Peak Level Advisors NEWSLETTERS
News & Articles
For an audio version of this article, click Play in the sound bar below.
A common question that people ask is what to expect from the stock market based on the outcome of elections. When a new presidential administration takes office, there is often a shift in policy from a prior administration, but those shifts are often incremental and may not have substantial economic impact, at least not one that overrides normal stock market fundamentals. There is much concern among investors today that the approach of the second Trump administration, which has been extremely aggressive in making significant changes, could cause a disruption of what has been a strong period of economic prosperity in the U.S., especially compared with the rest of the world. Of particular concern is the administration’s policies on imposing tariffs and the direct and ripple effects of the approach they are taking to reducing the Federal workforce. If you have been an investor for a while, it is likely you’ve seen your share of ups and downs in the markets, which is typical of how market cycles move. The question at the top of the minds of many is, will we continue to see cycles like we have historically or are we embarking on new territory. Unfortunately, it is impossible to predict what will happen in the future, but in times of uncertainty, it can be helpful to put even circumstances that have not been seen into some context. That is what we will attempt to do in this issue of the newsletter. The Cycles of the Stock Market If you have been investing in the stock market for a while, you probably have experienced your share of good and not so good time periods. It goes with the territory of investing that if you want your money to grow, you have to accept that risk is a part of the equation. What we tend to think of as risk is volatility, fluctuation from a smooth ride, and more specifically we think of negative volatility or downturns as the risk associated with investing. While that psychological element of fear is real, what sometimes happens is that if we’ve experienced a decent stretch of positive growth, our minds tend to forget about the downturns of the past, which makes us hypersensitive to a rough patch. However, to put the cyclical nature of the market in some context, consider that on average, there are more than 3 reductions of 5% or more in the stock market each year. While nobody enjoys those drops in valuation, it is normal. Despite the fact that those types of declines are normal, from 1928 to 2024, the S&P 500, which is what we now look at as the pre-imminent measure of the U.S. stock market, has finished the year in positive territory 71 times. That means in almost 100 years, the stock market has been up for the year more than 73% of the time. On top of that, the average annual return over those 97 years has been 11.66%. We can talk about averages all day, but the likelihood of you seeing an “average” year is pretty slim. In fact, there has been exactly 1 year in those 97 during which the annual S&P 500 return was between 11 and 12%. To further the point, of those 71 positive years, the average annual return was 20.93%. But you may ask, what about the 27% of negative years. During those 26 negative years, the average annual return was -13.65%. If you look at historical numbers within a given year, the first quarter tends to be more volatile than the rest of the year, especially between mid-February and early March, which tends to be the worst performing period of time. That has been especially the case in post-election years, during which the first quarter returns have hovered around a 1% average compared to a full year average closer to 8%. All of this is to illustrate that investing in the stock market often is going to be a choppy experience, but historically speaking, the direction of the market tends to be up if you can survive the cycles. The Impact of Elections on the Stock Market Let us first establish that election results have a greater impact on public policy than they do the long-term performance of the stock market. That said, public policy can filter its way into how companies spend, invest, and perform, which can ultimately impact stock performance, more so in the short-term than the long-term. Therefore, any conclusions we may attempt to draw about the impact of elections on the stock market from history are limited in that there have been a total of 24 presidential elections since 1928, not including the 2024 election. With that understanding, the general direction of the stock market between elections has been as follows: In the first year after an election, the markets have tended to experience periods of declines, especially early on, as a new administration implements its policies but still performing reasonably well, with the average return since the 2028 election being 10.26% The second year after the election, which is when mid-term elections occur, tends to be the weakest for the markets, often with increased volatility, with the average return since the 2028 election being 6.97% The third year after the election, during which candidates for the upcoming election throw their names into contention, often shows the strongest performance, with the average return since the 2028 election being 17.64% The fourth year after the election, or the year of the next presidential election, has seen a variety of outcomes as the markets react to the potential for changes in policies, with the average return since the 2028 election being 10.42% In addition to the outcome of the presidential election, another important consideration is the makeup of Congress vs. the White House. In past history, it has been more common that not that stock market performance has not been as strong when there is single party control of both the presidency and Congress, which is what we have following the 2024 election. Do We Believe History Repeats or Is This Different? We can look at all of the past statistics we want to, but the past cannot predict what will happen in the future. While there are often concerns about how the policies of a new presidential administration will impact the economy and the markets, the concerns about this presidential administration may be more pronounced than others. That is in large part because of the nature of the policies being discussed and the speed with which many of these significant changes are being implemented, along with the way the administration has sought to increase the power of the presidency without any substantial pushback from the Congress, which could exercise its own authority but has not up until now. This inevitably leads to the question of whether this time will be different than what we’ve seen in the past. There have been other circumstances in the past that have called into question whether historical trends would hold true or not, particularly in the recent past. Let’s look at three examples to see how the wisdom of the day played out. Example 1 - The Technology Boom Near the end of the 1990s, technology stocks were the hot commodity, driving stock prices to levels not seen in many years. At the end of 1998, the S&P 500 had averaged more than an 18% return over the past 15 years, and the Price to Earnings (P/E) Ratio (P/E) of S&P 500 stocks was at its highest point since 1998, indicating stocks were as expensive as they had ever been. Historically, when stocks get more expensive, there is a greater chance of a market correction, but many were claiming at the time that because of the technology boom, the trend would continue. In the following 4 years, the S&P 500 averaged a return of 0.35%, which included the protracted recession from 2000 that didn’t end until 2002. Example 2 - The Global Financial Crisis Most investors remember the pain of 2008, kicked into high gear when Bear Stearns, one of the world’s largest investment banks, folded. At that moment, we knew pain was coming, but the seeds of it were beginning to be seen in 2007, and the market reflected that with a paltry annual return of 5.48%. As the crisis came to a head towards the end of 2008 and the beginning of 2009, investor anxiety may have been as high as ever, and pundits were contending that a market bounce back was not going to happen anytime soon, defying history that has shown the resiliency of the stock market. In the following 4 years, the S&P 500 averaged a return of 25.56%, as part of an extended bull market that continued for more than a decade Example 3 - The COVID Pandemic A recent shock to the global economy was the outbreak of COVID-19 that essentially shut the world down for an extended period of time starting in March of 2020. Because economic activity came to a screeching halt, and it was hard to determine when the pandemic would be under control, the stock market took a massive dip, with the S&P 500 experiencing more than a 24% drawdown in about 3 weeks in March. At the time, the fear was that the abrupt disruption in economic activity would do major long-term damage to the markets. However, by the end of the year, the S&P 500 was more than 26% above where it started in March, and by the end of 2024, the S&P 500 averaged a return of 10.26% over the prior 4 years. So, on the question of whether this time is different, nobody knows. What may seem like stock market disaster waiting to happen can turn on a dime, in large part because despite all of the external circumstances that create anxiety in the minds of investors, the stock market tends to operate on the performance and expectations of the businesses that make up the economy. Only time will tell whether the concerns being felt today will lead to long-term negative consequences. As is always the case, you should make investment strategy decisions based on your personal circumstances and objectives, not based on the opinions and fears of what may or may not happen.
People often talk about and dream about getting rich. Unfortunately, for many that is more of a hope and a wish than anything else. Even the way the idea is worded points to luck more than a strategy. A more systematic and sustainable goal is that of building wealth. You get something that is given to you either intentionally or not, whereas, when building something, you tend to be more intentional and involved in creating the outcome. Another common misconception is that being in a good place financially is based on the income you make. While earning an income is critically important in being able to build wealth, how much income you earn is not necessarily the most important thing. Whether you’ve seen it in your own life or someone else’s, it is clear that earning a large paycheck doesn’t always translate to a financially healthy life. If you spend everything that you earn, you will have to keep earning forever to maintain your lifestyle. Most people don’t want to have to work to earn a living forever, and whether because of age or health, most people will not be able to work to earn a living forever. With that in mind, let’s look at what does make for a financially healthy lifestyle or you might even say financial independence. If you have to give your time and effort to support your lifestyle financially, there is at least some level of dependence in place. True wealth is when you don’t have to put in your own work to make a living, or stated another way when you can make money while you sleep. That happens when your money is working for you. This will be the focus of the Financial Empowerment Conference hosted by Turner Chapel AME Church, of which I am a part of the planning team, “Making Money While You Sleep”, which is another way of discussing how you can create sources of passive income. The conference will be held on February 28-March 1, 2025 at the church, and anyone interested is invited to attend either in-person or virtually by registering at this link. During the conference, we will have a panel discussion with professional experts in business, tax, and real estate to discuss strategies for generating passive income. In this issue of the newsletter, we broaden out to discuss multiple ways of creating income that you don’t have to get up and go to work to earn on a daily basis. Getting Ready to Create Passive Income The term passive income can send a message that no work is involved when that is not actually the case. Like so many other things, there is no “silver bullet” to creating passive income just like there is no “silver bullet” to building wealth. Unless you are fortunate enough to inherit a fortune or get lucky and win the lottery, you very likely will need to work your way over time to a place where passive income is something you can benefit from. I heard a question asked at a forum where someone wanted to know how they could quit their job and have the ability to just sit on their couch but still be able to maintain their lifestyle. If that is how you view creating passive income, you may be disappointed in what is required. If you want to create the kind of passive income that will enable you not to have to work to earn a living, you will most likely have to put in a significant amount of effort up front to get into that position. Why? In most cases, it takes money to make money. If you want to have the money/capital that will allow you to engage in the kind of activities that will generate passive income, you will have to not only earn money but save an invest in such that it builds a pool of assets for you that can be used to fund your passive income venture. So, in addition to earning money, you also will need to make good decisions on how you use what you’ve earned to establish the building blocks that can allow you to have the choice whether or not to work in the future. Passive Income that You Are Actively Involved In If you’ve done the up-front work to build your base of capital to create passive income opportunities, there are many places you can deploy that capital to make it work for you. As noted earlier, we will discuss some of those strategies during the Financial Empowerment Conference, but for the sake of time, we will take one of those strategies as an example of how you can make your money work for you - in real estate. Real estate is one of the most impactful wealth building tools we’ve ever seen, in part because as the saying goes, “they aren’t making any more land”. When you have a scarce resource like land, if you own some of that scarce resource, you are in a position to have that resource make money for you. Many who use real estate as a tool for passive income serve as landlords for residential buildings, in part because the cost entry point is something that they feel is more manageable. That approach of renting out real estate, an income strategy, allows you to receive income from a renter and have a profit if the rent is higher than the ongoing expenses paid, like mortgage, maintenance, and repairs. In the early stages of such a venture, the profits will likely be very slim unless a significant down payment is made on the property purchase; however, once the mortgage is paid off, the margins can increase substantially. In that sector, you can also be involved in buying and selling real estate to turn a profit, usually through buying and rehabilitating property at cost then selling it at a higher price. That approach may not take as long to be profitable, but due to the costs involved in acquisition and disposition of the property, not to mention the rehabilitation phase, it is important to be financially solvent and have skill at your disposal in terms of executing the strategy. In both approaches, while income is generated that you may not be directly working to earn, you will typically need to be actively involved in executing the strategy, at least early on. If you want to get to a place where you aren’t as actively involved, you may need to build a more significant business such that you can afford to pay others to manage the strategy while you collect the money. Working in the commercial real estate space can enable you to generate more significant margins and have more skilled people working on your behalf, and one of our conference panelists will be speaking on that topic. Passive Income Where You Can be Hands Off Generating passive income that you don’t need to have much involvement in is the ultimate Making Money While You Sleep approach. As noted earlier, getting to that place, you may need to take some smaller steps to make that possible. This kind of passive income typically comes from financial investment in something, whether a business or a financial instrument, where you are simply the means of funding to allow some other entity to perform its work. It’s akin to being a silent partner. However, if your participation is only as a money source, and you are not actively involved in doing the work, chances are your cut of the profit is going to be less than those who are actively doing the work. Therefore, to generate enough of this type of income to enable you to support your lifestyle and not have to work means that you are likely to need a much larger asset pool that can be used to fund these types of activities. For another example, we can point to making money from dividend paying investments (e.g. stocks, bonds, etc.). Let’s say you are investing in dividend paying stocks that distribute at a rate of 3% annually. If you want to live off the income those dividends pay and you need $75,000 of spendable income to live on, to generate that much in annual dividends, you would need to have $2.5 Million invested in those dividend paying stocks. Is that achievable? Certainly! Is it easy to get there? No. If your goal is to build wealth and have true financial freedom, at whatever level is required for you, real passive income is a valuable tool to make that happen. Sure, it is possible that you get lucky and do very little work of your own to have the kind of passive income that will support your lifestyle, but it is more likely that getting to that place will be a process. You may have to work, maybe harder than you want doing something you aren’t as excited about for a period of time, before you get to a place where you have the kind of capital to be able to live off purely passive income. It doesn’t sound easy because it’s not, but it is well worth it.
If you are one of the people who borrowed money for college and found that paying those student loans back has been far more challenging than expected, you are in the company of a large number of people, many of whom have watched with great interest in recent years as the U.S. Department of Education attempted to streamline Federal Student loan repayment and provide opportunities for forgiveness from those loans. Since the initial pause of the requirement to make payments on Federal Student Loans as part of COVID relief, many borrowers have gotten out of the habit of making student loan payments, and many were looking forward to the possibility of having their loans forgiven in total or in part. Over the last several months, however, court challenges halted plans that were in place that would have allowed reduced student loan payment requirements and broader options for loan forgiveness. With the incoming Presidential administration set to take office on January 20th, it is widely expected that the approach towards Federal Student Loan borrowers will change considerably. Because of the changes that have occurred since 2020 relative to Federal Student Loan payments, borrowers may have become accustomed to not having to make their loan payments. While it is unknown what the new administration will do differently than the old one, it would be a good idea for Federal Student Loan borrowers to get ready to resume making payments on their loans in the near future. With that in mind, in this issue of the newsletter, we will provide some updates in the world of student loans and highlight some things that have not and are likely not to be affected by the activity of the last several years. Guidance on Interest Accrual and Forgiveness from the Department of Education Many Federal Student Loan servicers began sending communications to their borrowers who had attempted to enroll in the SAVE repayment plan (a loan repayment plan that was intended to provide both lower payments and a more defined forgiveness structure). Because the SAVE plan was the subject of court cases, the full implementation of the plan was put on hold, but because some borrowers had already enrolled and others had applications pending, all borrowers in a current or pending status with SAVE had their loans placed in forbearance. During this forbearance period, no interest would accrue on those loans even though payments were not being made. In the communications from servicers, some seemed to indicate that interest was in fact going to start accruing even while loans were in forbearance. The Department of Education has clarified that is not the case and that interest will in fact not accrue as long as the loan is in forbearance. However, they did state that the time that loans are in forbearance due to the SAVE Plan litigation, does not count towards loan forgiveness. This differs from the treatment of COVID, when the requirement to make loan payments was paused and the interest rate was reduced to 0% between March 13, 2020 and September 1, 2023. Even though no payments were due during that time frame, for the purpose of calculating the number of months of payments made towards loan forgiveness, those months were treated as months during which current borrowers were making payments either for an Income Driven Repayment (IDR) plan or for Public Service Loan Forgiveness (PSLF). What Hasn’t Changed and Probably Will Not Change As noted, it was an emphasis of the Department of Education under the Biden Administration to put reforms in place to provide relief to Federal Student Loan borrowers in the form of reduced payments and avenues for loan forgiveness. Many of the initiatives they promoted had not been through the legislative process to allow Congress to pass them as law. As a result, when proposals were challenged in court, those efforts had to be put on hold because there was no standing law in place. The SAVE Plan is a perfect example of this situation. For many borrowers, it would have reduced their monthly payment by half, and it could have put them on a track for loan forgiveness earlier. Again, while there is no way of knowing what will happen in the future, it is highly unlikely that the Department of Education under the incoming Trump Administration will seek to promote the SAVE Plan. Nevertheless, there are still long-standing avenues for loan forgiveness through existing programs that have been passed as law. One of those is PSLF, which provides the opportunity for loan forgiveness if you have worked full-time in a covered job and made on-time payments for 120 months while in that covered job. Another avenue is the loan forgiveness terms that are a part of other IDR plans like Pay As You Earn (PAYE), Income Based Repayment (IBR), and Income Contingent Repayment (ICR), which allow forgiveness of the remainder of the loan balance after 20-25 years. Keep in mind that outside of PSLF forgiveness, when a Federal Student Loan is forgiven, the forgiveness amount is considered taxable income to the borrower. If you find yourself in a situation where you are evaluating a forgiveness option and are concerned about the tax implications, it is best to consult with a tax advisor. Making Your Plans for Loan Repayment Because there has been so much that has changed in the world of student loans over the last 4+ years, and many have gotten out of the habit of making their payments, settling into this new era may be a challenge. While the time at which new policies will be enacted is uncertain, it would be wise to expect that things will be changing in the near future, which means if you have had a pause in making student loan payments, it makes sense to put that line item back in your budget and making any other alterations necessary to manage your income. At the same time, if you have Federal loans, you can also reach out to your loan servicer to get an assessment of where you stand, what payment options you have available to you to help you manage the payment, and determine if you could take advantage of any of the forgiveness options in place. Of course, not all loan servicers are created equal, so if you have not had a great experience with getting quality information from your loan servicer, there are other avenues where you can receive help with keeping up with your student loan status. While this is not an endorsement, one such entity I have seen information from is an organization called Savi, which you can research by going to https://www.bysavi.com. Depending on what your needs are, they have free and paid membership packages that allow them to provide guidance to you on your payment and forgiveness options. There are other organizations and individuals who may be able to provide similar assistance if you are looking for help outside of your servicer. Whether you choose to do it yourself or engage an outside entity, it is likely that very soon, not addressing your student loan situation will no longer be an option, so it would be a good idea to begin now preparing yourself for what is coming down the road.
One of the highest priority areas of financial planning is creating retirement security. The definition of retirement means different things to people, especially compared to past generations; however, most people still look forward to the day when they no longer feel like they have to work to afford their lifestyle. As a result of this emphasis and the changes that have occurred in the last 40+ years during which traditional pensions have become few and far between, it is critically important that people take ownership of and make adequate plans to be financially prepared for retirement. For those who are building towards that goal, one of the major components is establishing enough personal savings such that they can draw from those savings over their remaining years to supplement other sources of income, which often involves saving in an employer or personal retirement plan. On almost an annual basis, the contribution limits on those plans tend to increase with what amounts to cost of living adjustments. However, there is a more significant change coming in 2025 with respect to retirement plan contributions. There are also pending changes regarding Social Security benefits for 2025. In this issue of the newsletter, we will explain what these changes are, who they impact, and how they may affect retirement readiness. Enhanced Catch-Up Contributions for Retirement Plan Investments Whether you contribute to an employer retirement plan or your own personal retirement plan through an Individual Retirement Account (IRA), your contributions provide the fuel to build your base of savings that will be used in retirement. Of course, the reason for putting that money at risk by investing it is to get the money working harder for you so it grows the asset base beyond just what you put into it. The higher your asset base grows to, the more of a role the return on investment plays in establishing your retirement readiness, but make no mistake, your contributions are always an important part of improving your retirement readiness. Because of the tax advantages associated with retirement plans, each type of plan has restrictions, including on how much you can contribute in a year, and the limits are higher for employer plans vs. IRAs. For example, the annual contribution limit in 2024 for most employer retirement plans (think 401k) is $23,000, whereas for IRAs the annual contribution limit is $7,000. By comparison, the limits in 2025 for most employer retirement plans will increase to $23,500, but the IRA limit stays the same. The above limits apply to investors below age 50, but because there is recognition that the closer you get to retirement, it is more critical to put as much money away as possible, there have always been catch-up contributions allowed for retirement plans for individuals age 50 and above. In 2024 the annual catch-up contribution amount allowed for most employer plans is $7,500 (total contribution allowed of $30,500), and the amount for IRAs is another $1,000 (total contribution allowed of $8,000). For those contributing to IRAs, there is no change planned in 2025. However, for those contributing to most employer plans, the catch-up contributions for investors age 50-59 will remain the same, but one of the big changes for 2025 is that there will be a higher catch-up contribution limit for individuals age 60-63 of $11,250 (allowing a total contribution of $34,750). Granted, not everyone is able to contribute at these levels to their retirement plan, but if you have the capacity and want to sock away more during your latter working years, this provision could make a real difference. Social Security Reform on the Horizon The vast majority of workers in the U.S. pay into the Social Security system through payroll deductions, and once eligible for benefits, they are able to use the retirement benefit of the Social Security system as a core source of income in retirement that provides cost of living adjustments to help fight off the effects of inflation. Several years ago, reforms were made to Social Security with the intent of strengthening its stability. As of this writing, there is legislation currently on the table that has been passed in the House of Representatives and is awaiting a vote from the Senate, called the Social Security Fairness Act, that would eliminate two provisions that primarily affect people who work or worked in government or other public service positions that do not make payroll deductions into Social Security. The two provisions are the Windfall Elimination Provision (WEP) and the Government Pension Offset (GPO). The WEP applies to people who worked most of their careers in employment that did not contribute to Social Security but worked long enough in Social Security covered employment to be eligible for benefits. These workers who don’t contribute to Social Security typically have a substantial amount of their paycheck withheld to fund a traditional pension once they retire. Without going into all of the details of it, the WEP applies a reduction to the calculated Social Security retirement benefit by lowering the percentage of one part of the benefit calculation from 90% to as low as 40% if you worked 20 years or less in a covered job. Chances are that if you worked limited years in Social Security covered employment, this reduction will have a larger impact on the calculated benefit. The GPO also applies to mostly the same group of people, but it impacts those who are surviving beneficiaries of Social Security retirement benefit recipients. Because the survivor in this case probably receives a fairly substantial pension rather than Social Security being their core source of retirement income, the GPO lessens the amount they will receive of their late spouse’s Social Security retirement, so instead of them receiving the full amount of their spouse’s benefit, it is reduced by two thirds of the amount of their pension benefit. If the Social Security Fairness Act is passed and signed into law in its current form, both of these provisions will be eliminated, thus providing former employees who did not primarily work in Social Security covered employment access to a larger amount of retirement income. Each of these changes could have sizeable ramifications if they apply to you, but as with so many such matters, it helps to apply it to your particular situation. If these provisions may affect you, and you want to assess the impact for yourself, we are available to help you make those determinations.
Now that the 2024 General Election has concluded, some of the things that impact our financial lives that we could only guess about before may start to become clearer in the near future. One of those items is related to what we will have to pay in taxes. As a part of legislation passed in 2017 with the Tax Cuts and Jobs Act (TCJA), there were a number of changes to tax law, but many of those provisions were temporary and due to expire at the end of 2025. We have no crystal ball into the future, but with that legislation occurring under the first Trump Administration, there is a likelihood that some, if not all, of those temporary provisions will be allowed to continue instead of expiring. In fact, if the new administration follows through on what was stated in the Presidential campaign, there may be new tax cuts that are enacted during the coming years. However, for this issue of the newsletter, we will focus on the tax law changes that are currently set to expire and the effect of them continuing on instead of ending as the original law set forth. Tax Rates and Income/Asset Limits The changes to tax law implemented with the TCJA changed the marginal tax rates for the 7 different tax brackets. Prior to passage of the act, personal income tax rates ranged from 10% to 39.6%, and after the rates ranged from 10% to 37%. With those changes, 5 of the 7 tax brackets had a rate decrease with only the 10% and 35% brackets staying at the same rate. Each year, the income limits for each marginal tax rate are adjusted for inflation, but the other thing the act did was to significantly increase the income thresholds for the formerly 33% and 39.6% (and currently 32% and 37%) brackets while lowering the income threshold for the 35% bracket. Of course, a lower tax rate at the same taxable income level will always result in a lower tax bill, but with the shift of the income thresholds in the case of the now 32% and 37% brackets result in a greater reduction in tax for households at those higher income levels. While people in the 35% bracket may not have seen their marginal tax rate increase, some of them had more of their income taxed at that rate because of the decrease in the income threshold. Overall, the combination of changes to marginal tax rates and income thresholds by themselves resulted in slightly less taxes due for households in the bottom 4 tax brackets and more significant tax reductions for those in higher brackets, so the extension of these rates will generally result in more of the same. The TCJA also lowered the Corporate Tax rate from 35% to 21%, which significantly reduced the taxes on net profits of corporate businesses. This provision was due to expire at the end of 2025, but during the Presidential campaign, Donald Trump indicated he wanted to lower the Corporate Tax rate even further, which would not only keep corporate taxes lower than prior to the act, but that would result in corporations receiving further reductions in income taxes due. Another potential phaseout from the TCJA is the income thresholds for the Alternative Minimum Tax (AMT), a separate tax calculation for higher income households that eliminates certain deductions from income in determining the AMT. These higher income taxpayers would then pay the higher of their regularly calculated income tax or the AMT. Prior to the TCJA, the amount of income required to qualify was adjusted annually for inflation (between 2% and 6% from 2006 to 2017), but the TCJA boosted those numbers from the 2017 to 2018 tax year by almost 30%, which had the effect of eliminating most households from having the income necessary to qualify for the calculation. Since that boost, the income thresholds for the AMT have gone back to annual inflation adjustment. Should this TCJA provision be continued, a very limited number of taxpayers would continue to be subject to this tax, whereas, if it were to expire, many of those higher earning households would need to determine if they owed more taxes by the AMT calculation or their regular income tax calculation. Tax Deductions and Exemptions One of the changes brought about by the TCJA was a change to how offsets to income were treated. Prior to the act, taxpayers could either take the Standard Deduction or Itemized Deductions (whichever was greater), and they were able to claim personal exemptions for the primary taxpayers and dependents on their tax return. The TCJA significantly increased the Standard Deduction for all taxpayer types (Single, Joint, Head of Household), but it eliminated the personal exemption. For some households, the higher Standard Deduction balanced out the loss of the personal exemptions. However, if you itemized your deductions, you lost out on the additional income offset of personal exemptions. For those who itemize deductions, home ownership can often provide a large portion of the tax deductions. The TCJA imposed a limit on the amount of the Sales and Local Tax deduction (SALT) of $10,000 combined. The SALT deduction is generally comprised of the amount of state and local taxes withheld from income or sales taxes paid and property taxes (such as Real Estate taxes on a residence). The $10,000 limit largely affected homeowners whose property taxes pushed their SALT deduction over that limit. Because of the interconnection of the deduction amounts, deduction types, and exemptions, it is more case dependent how the continuation of these provisions of the TCJA would impact households. However, the expiration of those provisions in general would more likely have a positive tax impact on households that itemize deductions, and the continuation of the $10,000 SALT deduction limit further reinforces that argument. For households who take the Standard Deduction, the determination of impact is more a function of household size, and thus the number of personal exemptions available. Another exemption that is currently due to expire at the end of 2025 is the Estate Tax exemption, which removes assets from being subject to the estate tax. Similar to the AMT described earlier, the Estate Tax exemption has been increased for inflation annually. The TCJA doubled the exemption limits from $5.6 Million for Single filers and $11.2 Million for Joint filers in 2017 to $11.2 Million for Single filers and $22.4 Million for Joint filers in 2018. The effect, of course, was to keep many more individuals from being subject to paying any estate tax. If this provision were to expire, the amount of assets subject to estate tax would fall back to around $7.15 Million for Single filers and $14.3 Million for Joint filers. For the majority of households, even the old exemptions would not cause estate taxes to be owed, so the continuation of the current exemption levels, adjusted for inflation, would largely benefit those with significant household assets. The last deduction impacted by the TCJA we will discuss is the Deduction for Small Business Income. The act allowed a 20% deduction of what is called pass-through income for sole proprietorships, partnerships, and S-Corporations. This income passes through from business taxes to personal taxes, so the deduction serves to lessen the hit of that pass-though income. If this provision were to expire, for businesses of these structures that take advantage of the deduction, they would owe a larger amount of income tax on business profits. Tax Credits There was not much in the TCJA in the way of tax credits that would be subject to the 2025 sunset provision, but the Child Tax Credit is one of those. The TCJA doubled the amount of the Child Tax Credit from $1,000 to $2,000 per child. Subsequently, post-pandemic, in 2021, the credit was increased further to $3,000 for children ages 6 to17 and $3,600 for children under age 6, but that increase was terminated at the end of 2021, returning the amount to the $2,000 in the TCJA. Of the $2,000 credit, in 2018, $1,400 of the credit was refundable, meaning that even if a household did not owe any tax, they could still receive a $1,400 tax credit, an increase from $1,000 before the act. The refundability of the credit receives annual inflation adjustment, so for 2024, the refundable portion of the credit is $1,700. The TCJA also increased the income thresholds at which the credit phased out, which allowed households with higher income to be able to claim the credit. If the increased Child Tax Credit were to expire at the end of 2025 per the current schedule, the credit would return to the $1,000 level, which would essentially cut in half the available credit to families with children. While the Trump Campaign indicated prior to the election the intent to extend the changes that were set to expire in the TCJA, you will need to stay tuned to see what is actually decided once the administration is in place.
Nearly 70 Million of the more than 330 Million Americans are enrolled in Medicare, the government’s health care insurance program for seniors. That enrollment has been growing by around 2 Million per year in recent years as our population continues to undergo its shift to an older nation. These demographics continue to put financial strain on this government program, creating cause for concern among so many Americans who rely on it for covering their health care needs. Despite being the pre-eminent health insurance for seniors, there are still many aspects about Medicare that are not as well understood as they could be. Many of those enrolled in Medicare just know that it is something that they are expected to do once they turn age 65, but to take full advantage of the benefit, it is helpful to understand more about how the program works, what your options are, and what requirements you need to adhere to. As we embark upon the open enrollment season for plans that begin in 2025, this is a good time to highlight important facts about the program and make note of some expected changes that will occur in 2025. Original Medicare vs. Medicare Advantage One of the key decisions you have to make when enrolling in Medicare is whether to choose what is known as Original Medicare, which involves having Medicare Part B as your primary insurance and adding a Medicare Supplement Plan. Under this approach, Medicare Part B tends to cover about 80% of the cost of care, and the Supplement, which is private insurance that plays a secondary role, tends to cover most of the remaining 20% of cost. Using this coverage strategy, you will tend to have more premium cost because you must pay the Medicare Part B premium ($174.90 for most people in 2024) as well as the cost of the private insurance that serves as the supplement. However, in exchange for the higher premium, you generally are not subject to some of the out of pocket costs, like doctor visit copays, that typically accompany HMO/PPO type plans. While much of the out-of-pocket cost is covered with Original Medicare, it only covers medical expenses, so if you want coverage for other services like dental, vision, etc. you will have to obtain those coverages separately. In addition, with Original Medicare, it is also important to enroll in Medicare Part D for any prescription drug coverage that you may need, which has its own premium payment required. The other plan option that has gained significant popularity in recent years is Medicare Advantage (also known as Medicare Part C), which is private health insurance that incorporates Medicare Part B into one package. The premiums for Medicare Advantage plans tend to be lower than those of Original Medicare, often with the insured person only having to pay the cost of the Medicare Part B premium. One of the reasons Medicare Advantage is gaining popularity is that in addition to the typically lower premiums, these plans can include additional features, such as prescription drug coverage, dental, vision, and hearing benefits, that are not available with Original Medicare. While the premium cost tends to be lower with Medicare Advantage plans, because these are private insurance plans, they tend to be of the HMO/PPO variety and thus can require doctor visit copays and some out-of-pocket expenses that may not be passed on to the customer who has Original Medicare. If you are unsure of which option makes more sense for you, you essentially can take the first year as a trial period because you can switch types of plans within the first year you are enrolled without having to go through underwriting for a new plan. What that means is that you can make a change without being subject to denial or the potential of being assessed a higher premium due to health conditions. Enrollment Periods and Timing There are a few key times to understand for enrollment in Medicare. First is the initial enrollment period. You have 7 months around your 65th birthday to initially enroll in Medicare, from 3 months before your 65th birthday month to 3 months after it. If you are still working and covered under an employer’s health plan, you don’t necessarily have to switch your coverage, but you should still contact Medicare during that time window to coordinate your Medicare benefits, which usually involves enrolling you in Medicare Part A, the hospital insurance coverage as opposed to your regular health insurance. The reason why it is important to enroll during this time window is that if you fail to do so, upon your initial enrollment at a later date, you will be assessed a permanent penalty that is added to your Medicare premiums for the rest of your life. The penalty is 10% annually for each year you should have been enrolled but were not. Besides the initial enrollment period, every year there is an Open Enrollment period that begins on October 15th and ends on December 7th that is for plans starting January 1st of the next year. If you are already enrolled in a Medicare plan and would like to keep it as-is, you usually don’t have do anything during the Open Enrollment period; however, plans can change from year to year, so it may be worthwhile to look at the upcoming year’s plan offerings to see if you want to remain in the plan you had or if it might benefit you to switch to a different plan. What’s New with Medicare in 2025 In addition to the normal changes to plan features and benefits, there are some other changes coming to Medicare in 2025. A list of some of those changes is as follows: 1. For enrollees in Part D plans, there will be a $2,000 out of pocket spending limit on prescription medications. 2. The proverbial Medicare “Donut Hole” goes away. Up until now, enrollees in Part D plans paid the full cost of prescription medications up to the annual deductible ($545 in 2024), and once the deductible was met, they paid a copayment amount until they reached a higher limit ($5,030 in 2024). Once they reached the higher limit, the amount the enrollee had to spend increased. With the elimination of the Donut Hole starting in 2025, going back to the first change, after the enrollee has reached the $2,000 limit, they no longer are required to pay additional cost. 3. Medicare Advantage Plans that include Part D may increase their costs or reduce coverage as a direct result of the $2,000 out of pocket maximum. 4. You will have the option of spreading out the cost of paying for prescription medications over a period of months rather than having to pay at the time of pickup. 5. The GUIDE program (Guiding an Improved Dementia Experience) will be expanding its resources by 4 times the number of organizations to provide a better experience for those contacting the program for support. Medicare can be a very helpful benefit to help seniors navigate their health care situation, but contrary to what seems logical, it can be significantly more complicated to understand than the insurance you often obtain during your work years. Whether you do your own due diligence to figure out what works best for you or engage a Medicare expert, it is worth your while once you get to this stage of life to make sure you are on top of things to make sure you maintain good health and don’t pay more for it than you need to.
For many months, there has been widespread expectation that interest rates will begin to drop. The Federal Reserve Board (The Fed) has been hinting at their intent to cut interest rates for some time, but as of this writing it is widely expected that a cut will finally occur after the board concludes their meeting this month. If you recall, the Fed went on an extended campaign of increasing interest rates after the COVID pandemic in an effort to reverse the rising rates of inflation. In the process, they raised the Fed Funds Rate, which is the rate banks pay to borrow money, multiple times after rates had been historically low for an extended period of time coming out of a series of shocks to the economic system. The Fed began hinting at their plan to cut rates in 2023, even indicating there were likely to be multiple smaller rate cuts during 2024 and likely beyond. However, their concerns about the level of inflation caused them to maintain the level of the Fed Funds Rate well beyond what most people had anticipated. So, with an interest rate reduction almost certain to come soon, in this issue of the newsletter, we want to highlight why so much attention is paid to interest rates from a larger financial perspective. The Fed’s Role and Use of Interest Rates to Enact Policy The Fed has a dual mandate with 3 primary objectives: maximum employment, price stability, and moderate long-term interest rates. The intent of the mandate is to drive a strong and stable economy where individuals who want to work can do so to adequately take care of their families. The Fed seeks to influence employment and inflation by using the tools at its disposal by altering the availability of capital in the money supply and by adjusting the cost of credit through interest rate changes. Since the level of unemployment has been relatively low for quite some time now since the heightened levels that occurred during the pandemic, the Fed’s major focus of late has been on getting inflation down to its targeted level of around 2%. That was the purpose of the series of interest rate increases that were enacted post-pandemic, and with inflation continuing to trend down closer to the desired target, the Fed is now seeking to determine the right timing to lower interest rates and how much to lower them. How Interest Rate Movements Affect the Economy and the Stock Market The overall goal for the Fed is to maintain a stable and growing economy. An ancillary item that goes along with that is a healthy stock market. While the Fed does not have levers to pull to directly impact the stock market, the steps it takes regarding economic growth tend to result in movement in the stock market because a growing economy will tend to benefit companies and with it their stock prices. However, the Fed’s impact on the economy does not always line up seamlessly with the stock market. The movement of the stock market reflects larger public sentiment of what is likely to come in the future, so stock prices tend to move in an anticipatory manner. Therefore, movements in the stock market will often happen in anticipation of what is expected, and if that expectation comes to pass, the trend often continues. On the other hand, if what is expected does not occur, the stock market will sometimes reverse course. As a result, the actions of the Fed often have a very swift impact on the stock market. By contrast, the actions of the Fed can take a significantly longer time to flow through the economy where it is actually felt by the public. For example, when the rate of inflation was in the 7-9% range in early to mid-2022, the Fed aggressively raised the Fed Funds rate by 3% from 0.25% in March 2022 to 4% in November of 2022. In subsequent months, they continued to raise the Fed Funds rate at a slower pace, up to 5.5% between the November 2022 rate hike and July 2023, which was the last rate increase in that cycle. During that time, inflation went from a high point of 9.1% in June 2022 to 7.1% by November 2022 and down to 3% by June 2023, and the rate of inflation had fallen to 2.4% by July 2024. While the impact of the rate increases slowly worked their way through the economy to lower inflation, the stock market made more dramatic shifts in response to actual and anticipated interest rate movements during that time, and as the rate increases ended and rate cuts were anticipated, the stock market has taken off since November 2023. Of course, there are other factors that have contributed to the growth of the stock market, but the expectations of interest rate movement has been in the background all the time. What to Expect from an Impending Fed Rate Cut When the Fed lowers the Fed Funds Rate, it will result in lower interest rates throughout the system. In turn, that tends to spur economic activity because businesses can borrow at lower interest rates and therefore engage in more investment activity to boost revenue, and consumers can borrow at lower interest rates to purchase goods and services. Mortgage rates will tend to drop as prevailing interest rates decline, allowing people to more affordably purchase homes. All of this is likely to take place when the Fed begins lowering rates, but it will take time to see that activity ramp up. If the Fed decides to lower rates at a faster pace, similar to the approach they took when they raised rates in 2022, the economic impact could be felt sooner. However, they have to walk a fine line in how much to lower rates because doing so too quickly has the potential of working against their goal of keeping inflation in the range that they want. From the perspective of the stock market, if history is a good indicator, should the rate decreases be slow and measured, there may not be a significant increase in the trajectory of the current stock market growth. It is even possible that there may be a slide in the stock market because rate cuts were less than anticipated. Much of the growth that has occurred of late has been in anticipation of coming rate cuts, so it may take bolder action on the part of the Fed to give the market an even greater boost in momentum. It is important for investors to always keep in mind that these stock market movements, whether in relation to interest rate policy or other economic activity, is cyclical and unpredictable. Therefore, it is wise not to place too much emphasis on what may happen in the stock market over the next quarter, six months, or even a year. Instead, it is wise to have longer term perspective, while using changes in the current environment to make small adjustments to take advantage of opportunities that may exist.
Investing is an endeavor to help you grow your money without you having to be the one putting in the work to make it grow. The amount you are likely to accumulate is based on three main factors: 1. How much you are able to contribute. 2. How long can you allow the money to work. 3. What type of return will you make on your investment. The first two factors are ones that you have more control over than the third. However, the return on investment is often what people focus on more than anything else. That may be because that is where a lot of media attention is placed or because it is easier to compare your investment returns to someone else’s. It is important when looking at investment returns to have the proper context because all investment returns, and investments for that matter, are not created equal. In these times where people do much of their investing in an employer plan or utilize “passive” investment strategies to grow their investment portfolios, it is really important to have context to understand what is happening with your investments and to act accordingly. If you have, for example, chosen to invest in funds mirroring the S&P 500 index to get broad exposure to the U.S. stock market, you may have been pretty pleased with your investment performance in the first half of the year. Unless you have been paying close attention, what may be less obvious, though, is that the lion’s share of that positive performance was based on the growth of a small number of the stocks that make up the S&P 500. While you may not care where the performance came from, the fact that a small number of stocks drove that performance, means that should those stocks stop performing as well, there could be an impact on the growth of your portfolio as a result. So, in this issue of the newsletter, we will discuss how you may want to approach your investments in a market such as what we are in now. What Does It Mean to be in a Top-Heavy Market To be clear, when you hear discussion about the stock market, for example in the financial report on television, they don’t report on the entire stock market What is used is indexes that essentially give you a sample of the stock market based on a group of stocks. Stock indexes are comprised of a group of stocks that represent a sector, stock exchange, or economy, and they are intended to indicate how stocks, and thus the performance of the companies they are sampling, are trending. Decades ago, when manufacturing was king, the index you would have heard reported on was the Dow Jones Industrial Index, but today the index that gets the most attention and is considered the most representative is the Standard & Poors 500 index (S&P 500), which includes 500 of the largest companies in the U.S. The goal is for investors to be able to gauge how a sector or the economy at large is trending based on the changes in the index because an increase in the index means the stock prices of the companies in the index have increased. However, the organization that creates the index determines its own approach to how it builds the index. Two of the common ways indexes are built are equal weighted and market cap weighted. An equal weighted index starts with the same percentage of weight to every stock contained in the index. For example, if the index contained 50 stocks, the value of each stock would start out representing 2% of the index. Of course, as time goes on and the share prices of the stocks change, the balance would change such that the equal weighting does not remain. A market cap weighted index considers the total valuation of each company whose stock is part of the index and gives greater weight proportionately to those companies who have higher valuations, meaning a very large company (e.g. Amazon) makes up a larger percentage of the index. This is where the top heaviness of the market comes into play. The S&P 500, which is typically considered the indicator of the performance of the U.S. stock market, is a cap weighted index. As of early August, the top 5 companies in the S&P 500 comprise more than 25% of the value of the index. In other words, 1/100th of the companies made up more than 1/4th of the movement in the index. Perhaps not surprisingly, the top companies in the S&P 500 are technology-based businesses. What perhaps is surprising is that Google, as big and influential as they are, is just outside of that top 5. To be fair, Google has two classes of stock that happen to be in positions 6 and 7, so if you combined those two share classes, they would fall inside the top 5. If you extend to the top 10 companies, they comprise more than 1/3rd of the value of the index. The impact of the fact that a relatively small number of companies have such an outsized influence on the movement of the index is that you may have unrealistic expectations of your own investment portfolio if you expect it to perform like “The Market”. Unless your portfolio is made up of investments that are the same as whatever index you are tracking, your performance very well could look different than that of the market at large. The Risks and Rewards of a Top-Heavy Market The concerns raised about a market that is top-heavy are the outsized influence a small number of companies have on its performance. The implication is that if you see strong growth in an index, like the growth the S&P 500 has experienced since late 2023, it could be that the move in the index is only representative of a few companies doing well. You may have heard the term “The Magnificent Seven” in reference to the stock market. That reference is for the largest 7 stocks in the S&P 500: Apple, Microsoft, Alphabet (parent company of Google), Amazon, Nvidia, Meta (parent company of Facebook) and Tesla. All of these companies are technology driven companies and have benefitted from the advance of Artificial Intelligence (AI). The growth of the Magnificent Seven stocks in the first half of 2024 was 31%, whereas the whole index was up 14.5%. The other 493 stocks in the S&P 500 were up 7.4%. With a small portion (less than 2%) of the index driving the growth of the index, the question becomes whether strong performance by the index means a healthy market or simply a few healthy companies. That represents the risk, taking good performance of an index that may not be broadly performing that way and extrapolating that to performance of the stock market at large. More importantly, for individual investors, what is important to understand is how your own portfolio is likely to perform rather than what the overall market or an index is doing. If you have invested in such a way that your portfolio mirrors the index, you can expect to see similar performance, for good or bad, but it is likely that your portfolio does not specifically correlate to a particular index. However, if for example, your portfolio was largely invested in the S&P 500 or even invested largely in the technology stocks that have been doing so well, you would be benefitting from that top-heavy market. Therefore, a top-heavy market is not necessarily a good or bad thing for you as an investor. What is more important is how your portfolio is constructed, which we will discuss next. Determining Your Investment Approach Make no mistake, you can alter your investment portfolio to position it to benefit from whatever direction a top-heavy stock market moves in, but unless you have more information than everyone else, those adjustments may be as much guesswork as anything else. As boring as it may seem, the prudent approach for most people is not to try and make a bet on how the market will behave based on the concentration of certain stocks at the top of the market, but instead it is to use smart investing principles that apply regardless of the market conditions. In other words, if you have a fairly lengthy timeline before you will need to tap into your investment, it probably is worth your while to maintain your normal posture, assuming you have set your portfolio up strategically in line with your objectives. If your timeline is extremely long, might you want to consider taking a little more risk by perhaps allocating some additional money towards specific investments or sectors that you believe have a chance to benefit from the current environment? That is always a consideration if you have plenty of time ahead of you, but it is often wise to not “bet the farm” but instead to take a smaller portion of your portfolio to take that kind of shot. On the other hand, if your timeline isn’t nearly as long, and you expect you will need access to your investment proceeds sooner, it may be a good idea to take some of your investments out of the stock market to minimize the potential for wide fluctuations in the value of your portfolio. When it comes down to it, whether the stock market is top-heavy or evenly distributed, in the long run, the stock market has historically performed extremely well. In the short run, the stock market is subject to periods of higher volatility that can impact not only the movement of the indexes but your own investments. Not that what has happened before tells us what will happen in the future, but leaning on historical context and the long-term trends of the stock market has tended to make for sound decision making and is more likely to help you achieve the outcome you desire.
As we await a broad reduction in interest rates, many people continue to feel the impact of the significant jump in borrowing costs resulting from the Federal Reserve’s (the Fed) measures that have allowed the rate of inflation to return to more historical norms. A decline in interest rates can take longer than we would like, and it certainly seems to take longer for them to drop than it did for them to rise. This phenomenon has perhaps been felt the most in the real estate borrowing market, where mortgage interest rates remain close to double what they were before the Fed’s rate increases. As the Fed continues to hint at when they may begin to lower the Fed Funds Rate, we have started to see interest rates on mortgages begin to lower lately. I recently saw an article that threw out the question, “Is now a good time for homeowners who had purchased a home in the last year to consider refinancing those mortgages?”, in that rates have begun to drop. Knowing that all indications are that rates may continue to drop, it seemed a little premature to think about refinancing now, but of course, none of us has a crystal ball to know when rates will fall and how much they will fall. With that in mind, in this issue of the newsletter, we would like to dig a little deeper into the mortgage refinancing decision to look at how you might determine whether you ought to consider refinancing now or in the future. Reasons to Refinance It may seem obvious why you would want to refinance your mortgage, but there actually can be different reasons to do so. Lowering your interest rate, and thus your mortgage payment, is clearly the most common reason to refinance. However, if lowering your payment is your main objective, there are other ways to do that than just lowering your interest rate. For example, let’s say you initially took out an FHA mortgage, which has the additional cost for the mortgage of a Mortgage Insurance Premium (MIP) for the life of the loan. You may consider refinancing to a Conventional mortgage even though it may have the additional cost of Private Mortgage Insurance (PMI) because PMI can be removed from the mortgage payment once you have paid your loan balance down to the point where the loan amount is less than 80% of the purchase price. Depending on the amount of equity you have in your home, that reduction in fees could make your mortgage payment more manageable. Another reason to refinance could be to shorten the life of your loan. The majority of mortgages have a 30-year term. While you can make extra payments to shorten the life of the loan, typically the interest rate on a shorter term loan, like a 15 or 20-year mortgage, is lower than the rate of a 30-year mortgage. Thus by refinancing to a shorter loan, you could reduce borrowing costs even though the shorter term more than likely would increase the amount of your monthly mortgage payment. Because you would be making that payment for a shorter period of time, it could lower your out-of-pocket costs long-term. Then there is the consideration of locking in a fixed rate if you are currently in an Adjustable Rate Mortgage (ARM). ARMs have parameters for when they can change the interest rate, which gives you less certainty of knowing what the Principal & Interest (P&I) portion of your payment will be (if escrow payments that would include taxes and insurance are part of your mortgage payment, those are not fixed). If you want that certainty for the P&I portion of the payment and if rates have dropped since you took on the ARM, refinancing to a fixed rate might be an attractive option. The Cost of Refinancing In a vacuum, any of the reasons we discussed to refinance seem completely logical, especially if it is going to either lower your monthly cost or reduce your cost over the life of the loan. However, the act of refinancing requires you to close on a loan, and that results in costs that you will incur. The costs may not be as high as an initial mortgage closing, but costs still exist, and it is important to evaluate whether the benefits of refinancing outweigh the costs. Typically, in a refinancing situation, to avoid having to come out of pocket with funds, people will roll the cost of the closing into the new mortgage balance. In that scenario, you have by default increased the amount of the monthly note. The good news is that can spread the cost over the life of the mortgage, but the bad news is that you are also paying interest that additional cost for the entirety of the loan as well. With that in mind, if you are considering a mortgage refinance, it may be to your advantage to do some comparison shopping to determine the costs associated with the process for lenders you are considering using so you can make sure the costs you would have to pay are reasonable. Nevertheless, the other factors that result in lower monthly or lifetime costs can certainly be worthwhile, but the numbers have to be right, which is what we will look at next. A Refinancing Example Maybe the best way to illustrate how you may want to evaluate the numbers on whether it makes sense to refinance or not is by way of some examples. These examples are intended to provide a better understanding for common refinancing scenarios and are summarized in the tables below. Scenario 1 – Desire to Lower Monthly Payment with a Lower Interest Rate Current Loan Refinance Opt. 1 Refinance Opt. 2 Outstanding Mortgage Balance $250,000 $257,500 $260,000 Interest Rate 7.500% 6.500% 6.250% Remaining Payments 350 360 360 Monthly P&I Payment $1,761 $1,643 $1,616 Monthly Mortgage Payment $2,338 $2,219 $2,192 Total of Remaining Payments $818,147 $799,004 $789,242 Total Remaining Financing Cost $366,519 $318,861 $307,187 Reduction in Remaining Payments $19,143 $28,905 In this scenario, the homeowner purchased their home with a 30-year mortgage near the peak of interest rates almost a year earlier and now that rates have declined, they are considering a refinance to lower their monthly payment. The interest rate they were quoted for a new 30-year mortgage was 1% below the 7.5% rate they locked in when they purchased, but they also got a quote to “buy down” the interest rate further for a larger amount of closing costs. With this refinancing approach, the mortgage term extends another 30 years vs. approximately 29 years left currently. This level of interest rate reduction lowers their mortgage payment by $119 to $146 per month, which over the life of the new loan lowers the amount paid out by approximately $20,000 - $30,000. Scenario 2 – Desire to Lower the Financing Cost Current Loan Refinance Opt. 1 Refinance Opt. 2 Outstanding Mortgage Balance $250,000 $257,500 $260,000 Interest Rate 7.500% 6.000% 5.750% Remaining Payments 350 180 180 Monthly P&I Payment $1,761 $2,110 $2,097 Monthly Mortgage Payment $2,338 $2,686 $2,673 Total of Remaining Payments $818,147 $483,430 $481,116 Total Remaining Financing Cost $366,519 $129,736 $124,921 Reduction in Remaining Payments $236,783 $241,598 This scenario puts a slight twist on the first one where the homeowner purchased their home with a 30-year mortgage near the peak of interest rates almost a year earlier; however, in this case, they are considering a refinance to shorten the loan term from roughly 29 years remaining to 15 years, which lowers the total cost of financing. As is the case with loans of shorter duration, the interest rate they were quoted for a this 15-year mortgage was 1.5% below the 7.5% rate they locked in when they purchased, and in this scenario they also got a quote to “buy down” the interest rate further for a larger amount of closing costs. With this refinancing approach, the monthly payment would actually go up by over $300 per month, but it would reduce the payment term by more than 14 years. This approach lowers the total financing cost by more than $230,000 over the life of the remaining loan. Scenario 3 – Desire to Lower Monthly Payment by Removing Mortgage Insurance Current Loan Refinance Opt. 1 Refinance Opt. 2 Outstanding Mortgage Balance $250,719 $258,219 $260,726 Interest Rate 7.500% 6.125% 5.875% Remaining Payments 215 216 216 Monthly P&I Payment $2,136 $1,919 $1,902 Monthly Mortgage Payment $2,848 $2,454 $2,438 Total of Remaining Payments $612,395 $530,070 $526,523 Total Remaining Financing Cost $208,618 $163,683 $157,629 Reduction in Remaining Payments $82,325 $85,873 This scenario requires more imagination and perhaps looking into the future, assuming that interest rates remain unfavorable for some time. In this instance, the homeowner purchased with a minimal down payment using an FHA loan at a 7.5% interest rate, but some 12 years later, having paid enough in to have reduced the loan balance to 80% of the original purchase price and in a more favorable interest rate environment, they are looking to refinance to a Conventional loan, which would allow them to stop paying the mortgage insurance as part of their escrow payments. In that they were almost 12 years into making payments, they did not want to go back to square one with a 30-year mortgage but also weren’t comfortable with a 15-year mortgage, so instead they chose a custom term of 18 years. By lowering the interest rate and eliminating the mortgage insurance from the payment, they lowered their total monthly payment by around $400 per month, which over the life of the new loan the amount paid out by more than $80,000. While the examples presented all yielded favorable results, the level of favorability varied greatly. If you are considering refinancing, you should understand what you are trying to achieve with the refinancing and run the numbers to see if you are getting whaat you seek. While a better interest rate is valuable, it is not the entire story, so consider the bigger picture if you are thinking of taking that leap.
The Empowerment Channel In Your Inbox
The Empowerment Channel In Your Inbox
Get Money Talks In Your Inbox
Get Money Talks To Your Inbox
CONTACT US WITH A QUESTION, COMMENT OR TO MAKE A REQUEST