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Liabilities: Not Just A Number On The Balance Sheet

By: Richard Feldman

By: Richard Feldman, CFP, MBA, AIF

Individuals and families are leaving thousands of dollars a year on the table by not effectively managing their liabilities. Most individuals tend to focus on managing their assets but spend very little time analyzing their liabilities. Individuals hire investment managers, financial planners, brokers and even hedge fund managers to make sure they are managing their assets efficiently but rarely do individuals consult professionals to see if they are managing their liabilities effectively. Analyzing your credit needs and loan options could save thousands of dollars in interest costs and shave years of the term of your loan.

Refinancing

With interest rates at historical lows you would think that most individuals and families have already refinanced their primary residence, but that is not the case. There are still a lot of people out there that could benefit from refinancing but have yet to take the plunge. The typical reason is that the upfront costs to refinance a loan are prohibitive and people think that they will never see the benefit of reduced payments. Most bankers charge approximately three to five percent of principal in closing costs to refinance a loan (This includes attorney fees and title searches). If you carry a large mortgage balance the benefit of reducing your interest rate will more than compensate for the up front closing costs over time. Here is an example:

Assume that an individual purchased a home in August of 2000 for $300,000 with twenty percent down at 7.5% fixed rate and a 30 year term. Principle and Interest payments on this loan would come out to be $1,678.11 per month. Total payments on this loan are as follows:

Financial Details:

Loan Amount: $240,000
Payment Amount Monthly: $1,678.11
Interest Rate: 7.5%

Interest Compounding: Monthly

Total Amount Financed: $240,000
Total Payments: $604,125.78
Total Finance Charge: $364,125.78

Now assume that an individual were to refinance this loan at 6% fixed rate for thirty years on the same principal amount. Principal and Interest on this loan would come out to be $1,438.92 a savings of $239.19 per month. Total payments on this loan are as follows:

Financial Details:

Loan Amount $240,000
Payment Amount Monthly: $1,438.92
Interest Rate: 6.0%

Interest Compounding: Monthly

Total Amount Financed $240,000
Total Payments: $518,012.58
Total Finance Charge: $278,012.58

The total savings by refinancing the loan would be $86,113.20. Furthermore, if you were to take the savings of $239.19 per month and put this towards the principle of the loan, you would shorten the term of your loan to 20 years and 11 months rather than 30 years. Because you will pay off your loan sooner, you will wind up paying less interest, which will reduce your total payments by $95,564.11. Here are the details:

Financial Details:

Loan Amount: $240,000
Payment Amount Monthly: $1,438.92 PI + $239.19 Pre-Payment
Total Payment: $1,678.11

Interest Compounding: Monthly

Total Amount Financed: $240,000
Total Payments: $422,448.47
Total Finance Charge: $182,448.47

Summary

CFPTM, CERTIFIED FINANCIAL PLANNER TM and are marks owned by the Certified Financial Planner Board of Standards, Inc. These marks are awarded to individuals who successfully complete the CFP Board’s initial and ongoing certification requirements. Federal Chairman Alan Greenspan recently said that individuals may be overpaying for the security of long term fixed rate loans.&nb