When it comes to debt, there are three kinds of Americans:
■ The debt-free. They receive interest on their savings. This is a small group.
■ The debt-ridden. They pay interest on their debts and receive no interest because they have no savings. This is a large group.
■ The in-betweens. They pay interest on some debts and receive interest on some savings. This is also a large group. Their eventual goal is to have the interest income they receive exceed the interest they pay.
Today, the first two groups are stressed. Those who are debt-free struggle because a major source of income is disappearing as yields decline. The debt-ridden struggle because it’s hard to pay down debt when your income from labor is in danger or shrinking.
But the people in between have a major opportunity — refinancing, especially of home mortgages. What you may not know is how powerful it is compared to all the alternatives.
Refinancing isn’t easy. It requires a lot of paperwork. But it can save you far more money than you’d earn on any interest-bearing investment. Indeed, a case can be made that refinancing is a better move than investing in the stock market, with far less risk.
Here’s an example: George and Sally Mugwump live in a $250,000 house they bought years ago. The mortgage balance is $150,000, at a rate of 5.5 percent. This year, they expect to pay about $8,250 in mortgage interest. They have no credit card debt and own their cars free and clear. They make regular investments in their 401(k) plans and have $10,000 in emergency cash.
Frustrated by a savings account yield of less than 1 percent at a bank, they moved their money to a bank offering reward checking. Now they earn 4 percent on their emergency cash account. Since they will earn $400 a year on the account, their net interest expense is down to $7,850.
They would like to do better.
Their best bet is a “refi’’ of their home mortgage. A refi that brought their interest rate down to 4.5 percent — easily done in the current market — would cut their interest expense by $1,500 a year. (It would also reduce their monthly payment, but that’s another story.) If the cost of getting the mortgage refinanced is 2 percent of the mortgage value, or $3,000, it will take only two years to recover their “investment.’’
Over 10 years they would save $15,000 in interest charges. That’s five times their initial “investment.’’ Can any other use of their money come close? Not likely.
It is possible that the stock market will double over the next 10 years. But there are also rumors of pigs learning to fly. Even if stocks doubled in value, the gain would be far less than rising to five times its current value.
Should you refinance? Yes, if you can do it at low cost and the payback is fast.
Scott Burns is a syndicated columnist, Boston Globe October 13, 2010