Jubak's Journal
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Have you mortgaged your future?
If you refinanced your home loan, it's possible. The Fed wanted us to spend, and we did by taking equity from our homes. But that could make your retirement less comfortable.
By Jim Jubak
If the Federal Reserve hadn't cut interest rates, the economy would be staring upward from the bottom of a deep, dark hole.
Economists wouldn't be worried that first-quarter economic growth was weak at 1.6%. They'd be lamenting a third or fourth straight quarter of declining activity. Unemployment wouldn't be simply bad at 6% but terribly painful at 8%.
It's true that nothing has done much good on the corporate side. Business investment fell again in the first quarter. But the Feds moves kept consumers spending on cars and houses, kept them dining out and buying clothes, and kept the aisles reasonably full at electronics and home-supply stores.
This has happened despite a steady rise in the total debt that consumers owe, to $1.7 trillion in 2003 from $1.3 trillion in 1998. Thats a 32% increase in just five years, which is more than enough to have kept economists worrying that an overburdened consumer would soon stop spending.
Spend, spend, spend
Yet the Federal Reserve's interest-rate cuts kept these deeply indebted consumers spending by lowering the interest payments on all that debt. Despite the big run up in overall debt, the percentage of disposable household income going to service that debt has remained just about constant, climbing to just 14% in 2002 from 13.5% in 1990.
If youve refinanced a mortgage in the last two years, you know how this works. The monthly payment on a 30-year fixed-rate mortgage for $155,000 at 6.875% comes to $1,017. At recent rates of 5.25%, monthly payments drop to $855 a month, leaving $150 a month that can go into current consumption.
That's only part of the picture. By taking out a home-equity loan at 6% or less, consumers have been able to tap into the rising value of their homes to pay off credit-card debt with interest rates of 9.9%, 12.9%, 16.9% or more. Or they just spend it.
The Fed says that homeowners used $200 billion in home-equity loans in the last 12 months, providing a significant shot in the arm for a faltering economy.
But much of this short-term stimulus to the economy comes out of the long-term retirement savings of consumers.
Stretching it out
Appreciated real estate is one of the biggest sources of retirement savings. The $200 billion in home-equity borrowing last year reduced the total national wealth locked up in homes by 3% in just one year. But the timing of the borrowing on home-equity lines and the timing of mortgage refinancings are likely to have an even bigger impact on retirement for the 76 million in the baby-boom generation who are facing retirement.
Most of the mortgage financings in the recent boom have pushed out the dates at which those mortgages will be paid off. For example, baby boomers with 23 years to pay on an existing mortgage have taken out new 30-year mortgages. Holders of 15-year mortgages with seven years left to pay have taken out new 15-year loans. Relatively few borrowers have used a refinancing to shorten the number of years on their mortgage debt.
And that stretch-out is critical. Research indicates that a paid-off mortgage is one of the best predictors of a comfortable retirement. A paid-off mortgage knocks, say, $1,000 out of the monthly cash flow that has to come out of retirement savings. That's significant when you realize that generating $1,000 a month out of a retirement portfolio earning 8% requires $150,000 in retirement savings. Or it would require more if the future rate of return is below 8% and more if the monthly payment is more than $1,000.
Delaying the pain
Add that to the new long-term debt created by home-equity borrowing, and millions of baby boomers have signed deals that cut their current payments and reduce the total interest paid, but schedule substantial debt payments in the retirement years.
This wouldnt be so scary if other parts of the retirement system werent under strain. But some projections show that the Social Security system, which historically has provided about 20% of retirement income, will have to reduce benefits at some point during the baby-boomers retirement. Pensions, historically about 24% of retirement income, are being cut back or eliminated.
Health benefits for retired workers have been one focus of the cuts. In 1988, 66% of companies offered health benefits to retirees, which fell to 34% in 2002, according to the Kaiser Family Foundation.
Consumers have indeed bailed out this economy, as the Federal Reserve planned. But at what cost to their own future in retirement?
Editor's Note: A new Jubaks Journal is posted every Tuesday, Wednesday and Friday. The Wednesday edition stems from Jim's appearance on CNBCs Business Center most Wednesday nights at approximately 5:45 p.m. ET. Selected CNBC stories can be found in the TV Reports index.
At the time of publication, Jim Jubak didnt own or control shares in any of the equities mentioned in this column. He does not own short positions in any stock mentioned in this column.
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