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Did we waste an opportunity of a lifetime ?
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2007 Feb 5, 3:40pm 17,562 views 178 comments
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Interesting thoughts on the interest rate arbitrage. I have been debating this internally for a bit. My scenario is short term debt on a depreciaiting asset (car not a house). In my case I can pay for the car in cash or try and out perform the market rate of the car loan.
See if my math holds up:
Purchase Price: $50,000
Interest Rate: 6%
Total Cost after 60 months: $65,000
Liquid assets: $50,000
Investment returns at 5.25% CD (annual): $2,625
Taxes on Investment returns (30% bracket): $787
Net from Investing funds: $1,838
Net funds after 60 months investing: $9,190
Asset Cost minus Investment gain: $55,810
So in my case the qeustion becomes: is it better to spend the extra $5800 over five years to stay liquid and hope the FED raises rates to the point that my CD's will outperform the loan I have taken out on the car. How high does that rate need to go in order for me to break even with the 30% in taxes I am forced to pay on the gains? What would you do here?
It seems this scenario would do better with a mortgage since the interest write off should counter any investment gain. Thus leaving me with a theoretical o% financing opportunity. That is assuming I could pay cash of course. Interesting stuff! Thoughts?
Low interest is only good if you're able to either park it into something that'll grow faster than the accrual of the interest or if you'll use the money to get more utility now than it'll cost you in utility when you pay it back. It can totally break down in a stagflation environment.
Peter P
2007 Feb 7, 6:43am
It can totally break down in a stagflation environment.
How so? Whtat if you can generate enough return to outrun your fixed interest debt?
The Patrick brown shirt bear army can now stand down,
The housing sector slump remained a source of uncertainty for the economic outlook, but there were signs of stabilization, he said.
Any spillover effect from the housing slump — either from a downturn in the sector or a decline in the so-called “wealth effect†— has not materialized and was unlikely to do so, Plosser said.
Now that's a relief.
Patrick being a fascist that has "brown shirts" in his employ, ie the "bear army" those who steadfastly ignore all new paradigms and refuse to participate in the great cash giveaway.
"How so? Whtat if you can generate enough return to outrun your fixed interest debt? "
Me earlier - "only good if you’re able to either park it into something that’ll grow faster than the accrual of the interest." I'm not a particularly good guesser.
So in my case the qeustion becomes: is it better to spend the extra $5800 over five years to stay liquid and hope the FED raises rates to the point that my CD’s will outperform the loan I have taken out on the car.
Your math is correct. But there is an additional risk - 1 year from now, the interest rate on CD might be a whole point lower than that is today. Of course if the rates drop, you can just pay off the balance. It's a gamble on interest rates.
The crucial difference is (and a benefit in your case) NEEDING the loan vs CHOOSING the loan. Betting on the direction (and spread) of interest rates is one of the riskiest forms of investing. Since you are able to pay off the loan, by postponing the decision by a fixed duration you can take a measured risk.
Personally, I don't do this. But that's my investment style.
Peter P
2007 Feb 7, 7:00am
Patrick being a fascist that has “brown shirts†in his employ, ie the “bear army†those who steadfastly ignore all new paradigms and refuse to participate in the great cash giveaway.
You are right, only a fascist will openly decline the American Dream. :-P
Debt is your friend. Debt = Wealth.
Not debt advice
Stretch002,
Firstly you're a W-2 (not a 1099) guy right? I could be wrong here. We'd need to know that before we can move forward.
Some time back a very smart poster brought to our attention that in truth MID doesn't really come of any great benefit until after you've broken your 10K standard deduction (married filing joint) AND a MAX 401K contribution! So if the SD is $10,300 this year and say $15,000 for the old retirement plan you'd need to break $25,300 on your schedule A.
OR!!! You could have a $2,108.33 per mo. MID w/no 401K contribution? :)
Peter P
2007 Feb 7, 7:05am
What did you have for lunch?
Pasta.
Now I feel like sushi for dinner. :(
Now you remind me to crank out some pasta for dinner. That piece of dough has been sitting for long enough!
Peter P
2007 Feb 7, 7:09am
Now you remind me to crank out some pasta for dinner. That piece of dough has been sitting for long enough!
Oh FRESH pasta!!!
I am also conceptualizing some white-wine cream sauce for ink pasta.
StuckinBA,
Good analysis! And you're right, I've bet on rates on gotten burned (who hasn't, right?)
More importantly though the difference between "needing" the loan and "choosing" is an important distinction. A nice problem to have. If Stretch is a 1099 guy (or...... could potentially become one) that changes things considerably.
If you have a classic like X's T-Bird (not a daily driver) than obviously cash is the way to go! But for something that's sharing the road with half-wits that think "it'd be a kick to be on Cops" I'd let the bank and the ins. company take the risk. That's just me.
Peter P
2007 Feb 7, 7:18am
But remember the golden rule of shortcuts - anything that makes it easier on the way IN will make it proportionately more painful on the way OUT.
No exit strategy then.
SP,
Proportionately or exponentially?
Btw, what IS "ink pasta"? Anybody? :(
Peter P
2007 Feb 7, 7:21am
Btw, what IS “ink pasta� Anybody?
A type of pasta made with squid ink. It is usually black in color.
So..... mortgage+gang+bangers+bankers?
I think we have one for WordSpy!
It sounds like I need to give you alittle more background so you can help me analyze this decision. Thanks in advance for indulging me. I am indeed a W-2 wage earner who is married. My wife and max our 401k's each year at the $15,000 limit. We are in the 30% tax bracket and have a household income between $200k - $300k. We are renters and have somewhere between $350k - 400k in liquid assets which are not retirement related. Our only debt is the 50k car. What do you think?
I believe Peter P is thinking of pasta made with squid ink, for inky black goodness!
HAHA
Mortgage Bangsters is hilarious! Nearly spit out my soda on that one!
Making risotto with squid ink is a traditional Venetian dish, or so my cookbook claims.
Peter P
2007 Feb 7, 7:36am
Hmm, that doesn’t look too appetitizing…
This is why I propose a wine-cream sauce. It needs something white. And perhaps some cherry tomatoes.
Also, I think restricting seafood to scallops, prawns, and clams would be better.
Peter P
2007 Feb 7, 7:37am
Making risotto with squid ink is a traditional Venetian dish, or so my cookbook claims.
IIRC Cascal on Castro in Mtn View has a paella dish with black ink noodle.
I like fried calamari, as long as it's fresh and made with a very light batter.
Peter P
2007 Feb 7, 7:39am
I like fried calamari, as long as it’s fresh and made with a very light batter.
Same.
I also like calamari or octopus stewed in a spicy tomato sauce.
Peter P
2007 Feb 7, 7:40am
Actually, tempura batter (light batter with ice + water) is pretty good too.
Tempura is good, but I think it would result in too much batter to calamari for my liking.
Peter P
2007 Feb 7, 7:44am
Tempura is good, but I think it would result in too much batter to calamari for my liking.
True.
What is the best dipping sauce for calamari? I like mayo.
Peter P
2007 Feb 7, 7:46am
My wife loves calamari salad with lime juice and red onion (Thai style).
I have no idea about "best," I prefer malt vinegar or basalmic vinegar on most things.
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For years the interest rates have been super low. Many argue that we really didn't need them to be so for so long. But that's what they were. Effectively, the cost of money was super low. That sounds like a good thing. At least it should have been a good thing in my naive viewpoint.
But what do we have to show for this ? We as American society, what is that we have done over last few years that we can look back and be proud about. There is little disagreement about how we blew it on a political and fiscal level. But from a non-government angle, just as a capitalistic society, how do we fare ?
As individuals, we seemed to have completely botched the golden chance given to us. Many homeowners could have refinanced their debt to a super low fixed rate for next 30 years, reduced their monthly cash out flow and increased their equity - all in one shot. But rather they chose to gamble with even lower payments to risk higher payments just a few years down the road. They took cash out of their equity - not to invest or start a productive business - but to consume and now don't have much to show for it.
But what did the businesses do ? Did they use this opportunity wisely ? Have they invested the money that might bear fruits down the road. Some of the reports indicate that many companies in the SP500 index have much stronger balance sheets than what they had a few years ago. What role in it was played by cheap money ? Or was it more due to outsourcing and simply a general recovery after a recession 5-6 years ago ?
Or was this even an opportunity ? I think it was. But then do we have anything to show for it ? There has to be something good that came out of this. Or we collectively just simply blew it all away ? On all fronts ?
StuckInBA