Decoding Debt

Mortgage rates are up...but you probably already knew that, if you have read, watched or listened to any media outlet over the past few months. The real estate industry would give the advice to "marry the home, date the mortgage", in the hopes that they can keep demand up.

It is possible that the Fed will reduce rates at some point, but that will only happen if inflation is under control or the economy tips into a recession where some monetary stimulus would be warranted. The age-old advice to live below your means and to only buy something if you can afford, holds as true today as ever

In general there are two ways to borrow, first with fixed costs, think your traditional 30 year mortgage where the rate you pay is locked in over the term of the loan. The second way is with a variable cost structure, so as rates rise and fall the interest you pay goes up or down with it.

Here are some examples of debts or loans with variable rates where those higher rates can impact budgeting and saving and lead to greater delinquencies or defaults:

Adjustable-rate mortgages (ARMs): These are mortgages with interest rates that fluctuate based on changes in the prevailing interest rate. Mortgages like these often offer a lower fixed rate to start, but then can adjust upward with prevailing rates typically annually.  Some of these loans have annual adjustment caps, limiting the increase from year to year or an overall cap on how high the rates can go.  Many of these rates were in the 3% territory for the last decade, they are being reset north of 6 or 7%.  

Home equity lines of credit (HELOCs): These loans allow homeowners to borrow against the equity in their homes. For example if you bought a home for $400K that is now worth $500K, you may opt to tap into that appreciation to cover renovation projects or educations expenses.  HELOCs typically have variable interest rates, these loans generally have a floor rate that the banks will charge to borrow but variable rates that reset as often as their benchmark rates (SOFR) change.

Credit card debt: Credit card interest rates are typically variable, with many rates today north of 20%. As a result, carrying credit card debt becomes more expensive and is considered one of the worst types of debt to maintain.  Generally, the first bit of financial advice a planner will suggest is to retire the credit card debt.  Many financial predicaments arise from ballooning credit card debt.  If you have a $10,000 balance the annual interest may very well be north of $2,000.  Making just the minimum payment is often a slippery slope.

Personal loans or lines of credit: Some personal loans have variable interest rates, which means that they can become more expensive to repay as rates rise.  These loans may be for starting a small business or for a home renovation where the house doesn't have much equity at present.  In addition to generally higher rates, these loans are generally recourse loans so your personal property is the collateral. You may be able to borrow directly from a bank or use your assets for collateral, though you investment assets cannot be used as collateral to buy securities.

Workplace Retirement Plan Loans: 401(k), 403(b) and 457 plans may offer loan provisions whereby you are able to access a portion of your vested balance of your retirement account. Usually capped at the lesser of 50% of the vested balance or $50,000 these loans allow you to take a loan for general purposes where the repayment period can be no longer than 5 years or for a home loan which will allow a 30 year term.  The latter will generally require additional documentation.  Here you are paying back yourself, typically at rates close to where rates are at the bank. There are a few potential downsides, you are typically selling securities in the account to fund the loan balance, missing out on any potential appreciation of those dollars and the loans are repaid through payroll deductions which can impair cash flow.  Most importantly many of these loans must be repaid within 90 days of separation of service

Margin: A form of borrowing associated with one's investment accounts, here an investor typically has borrowing power equivalent to 1/2 of the accounts value.  For example, an investor with $500K can borrow approximately $250,000.  Margin loans are easy to apply for and have no application fees they however have a greater degree of risk assuming you are borrowing close the permitted limit and markets or individual holdings may be variable.  Tread lightly here, these are best used as bridge loans in our experience.

If you have more than one balance outstanding, there are two common approaches to debt repayment and they are as follows:

1.    The Avalanche method – This method is where you make minimum payments on each balance and take any other money that is earmarked for paying down debt and put it toward the balance with the highest interest rate.

2.    The Snowball method - This method is where you make minimum payments on each balance and take any other money that is earmarked for paying down debt and put it toward the smallest balance.   The idea with this method is to quickly payoff one balance, so that monthly obligation is eliminated, and that monthly amount can be focused on the next smallest balance, until all debt is paid off.  This approach makes a lot of sense when the interest rates across the various borrowings are very similar.

Both methods are good strategies to help you reduce monthly expenses and avoid getting trapped in a cycle of debt.

So what to do now...

Money market rates at present are attractive when compared to rates on cash over the last 15 or so years – the problem is that none of us live in a vacuum.  Inflation is at its highest level since 1981 which means cash, even at 4%+ isn’t the answer other than for near term expenses or that ever important emergency fund.   CD rates may offer slightly higher rates because you are locking the money up for a period of time, sure they may look good now but not when compared with MUCH higher credit card rates.  As the cost of living continues to increase, servicing your debt can be a significant burden on one's finances and limit the ability to save for the future.  While paying off your high costs debts should be the top priority, we would encourage  you to simultaneously build up, an emergency fund.  Having the "rainy day" fund is crucial for unexpected expenses, such as job loss or medical emergencies, which can happen at any time and seem to surface at the worst possible moment. Without an emergency fund, individuals may have to rely on credit cards or loans to cover these expenses, further compounding any issues.


Financial planning comes in many forms and great planners can help across a range of financial decisions. Planning is often focused on the big life events like retirement, estate planning, divorce or college funding for a child but the reality is that there are MANY small decisions at every stage that can make an outsized difference.

That's a good primer for understanding the credit markets and there are additional more complex debt structures beyond the scope of this discussion, it's safe to assume leverage can be both a real asset when used wisely and an even greater liability when not, try your best to not over-extend.