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The Borrow Smart Chronicles - What is Opportunity Cost in Lending?

The Borrow Smart Chronicles - What is Opportunity Cost in Lending?

Episode 40

Todd Ballenger
August 16, 2024

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“I think high self-esteem is overrated. A little low self-esteem is actually quite good…Maybe you're not the best, so you should work a little harder.”

Jay Leno

expectations for mortgage applications

We are starting to see movement, sentiment is shifting for refinance candidates who have been layering additional debt and now have a ‘blended rate’ that incorporating all their debt might make it worth while to consolidate into an overall lower rate. The next big jump happens when the FED starts to drop and we see the positive impact of both the lowering of rates, and the lowering of volatility that will cause rates to possibly drop faster than some might expect.

Be ready - get all your clients in a queue with their objectives so you can move quickly, but set expectations now that the industry is smaller than it was, and while the liability advisor is ready for some action, the back offices may not be ready for a big spike in activity. Be like water… one day at a time!

a BORROW SMART CONCEPT
LAG - Liability Asset Gap

This is a concept from our CLA course, and many over look it as interesting, without realizing the profound impact it has on everything we do. This GAP, often called ‘opportunity cost’ or ‘arbitrage' if you are fancy… is essentially the understanding that in the money game, there are always two sides that make up the money ‘see saw’.

There has been a lot of talk about the ‘Yen Carry Trade’ - google it and you’ll find a big list of explanations. It’s a broad example of this concept. A borrower could borrow money in Japan at 1% and then invest in the US at 5%, that is the LAG - you can make 4% with some currency risk, and interest rate risk… remember you are earning the difference between the 5% and the 1%. If Japan raises rates to 2% and the US drops rates to 4%, now there is only a 2% benefit, and there is more risk.

How is this practical as a CLA? It depends on your time frame.

Longer Term: As I discuss in Borrow Smart Repay Smart - the gap over long periods of time are such that the market returns on investments are higher than the average cost of borrowing over any 30 year period of time. This means that similar to the Yen Carry Trade, the typical consumer would be better off not prepaying their mortgage and instead investing over time.

Shorter Term: If you currently have a mortgage at 4%, and a car loan at 6% and a personal loan at 8% and credit card debt at 20%, and you look at your carrying cost on those debts, if the blended rate is 7% on all that debt, there is an immediate opportunity cost of waiting, as today you could ‘restructure’ that debt at closer to 6%. If rates move down further you can restructure again, and benefit from refinancing, to close the gap.

If my mortgage is 4% today, and I want to take money out without refinancing that cost of debt for an equity line of credit might be 7 or 8% today. That makes sense to pay off credit card debt of 20%, but it might not make sense to invest in the stock market to earn 7 or 8%.

The ‘IT Depends’ is the most important part of all these discussions, and a professional will always know what the ‘it depends’ is for any particular customer.

much of this is likely going to higher interest rate debt refinancing to avoid touching the first mortgage which is still at a lower rate

LIABILITIES and DEBT
What’s Happening.

great look at rate cut expectations

rates are dropping for those not in the industry

many expect us to settle into this 5.5 - 6.5% range over the next few years…

Torsten Slok - h/t Mike Zaccardi - let’s make ARMs great again

not sure I’d say seriously as the percent underwater is really small

slight increase in delinquencies last quarter (Q2) but consumer will defend their equity as long as they can

many are quite fragile - and this is why jobs reports are so important

most can’t cover a $400 expense, and losing a job means they are quickly underwater and unable to make mortgage payments

great chart from Keeping Current Matters - this equity is only valuable if it is accessible - see Liquid!

“Live your Life. Live your Life. Live your Life.”

- Maurice Sendak

REAL ESTATE
What’s Happening?

improvement from prior week - good headlines over First Time Homebuyer programs and incentives to build new inventory

new housing starts are trending down over the last year

this could help with afforability

Investors buying 1 of every 6 houses sold

but there is a wave of first time buyers on the horizon

“The bad economist sees only what immediately strikes the eye; the good economist also looks beyond. The bad economist sees only the direct consequences of a proposed course; the good economist looks also at the longer and indirect consequences."

- Frederic Bastiat

ASSETS and INCOME
What’s Happening?

a tale of two markets, either way volatility is still up bigly but coming down

consumers dove back into that first pullback - eventually the ‘buy the dip’ won’t work

@MacroCharts - due for a bounce and it came right on time… driven by liquidity?

but income and housing are both trending up

and stock ownership keeps rising which is GREAT if the market keeps going up

consumers are getting more defensive

“Things turn out best for the people who
make the best of the way things turn out.”

John Wooden

ON BEING HUMAN
What’s Worth Sharing?

In 1995, 14 wolves were released in Yellowstone National Park. No one expected the miracle that the wolves would bring
[📹 Protect All Wildlife]
— Massimo (@Rainmaker1973)
3:15 PM • Aug 9, 2024

North, East, South and West

Four friends set
out from where
they stood.

One went North.
One East.
Another South.
The last one, West.

Each in search
of meaning.
Each in search
of the point of
their own life.

Three would continue
along the never ending
road of becoming
someone.

Each of them assuming
they needed to be
somewhere other
than where they were.

But one would come to
know the significance
of standing still.

Nic Askew - The Significance of Standing Still

DOPAMEMES
And Other Happy Moments…

I’ve had some interesting conversations, give it a go: https://gemini.google.com/app
“I'm thinking about buying a first home. What should I consider?”
If you haven’t check out: First HomeIQ