Q&A with CMMB Securities

Q. I’ve heard that refinancing my mortgage can reduce my monthly payments as interest rates are low right now, but when the rates go back up won’t I be back to square one?

Lenore, St James

A. The rates on most mortgages are fixed for the term and so if you refinance your mortgage today and rates subsequently go back up again, the rate on your mortgage would stay constant. Therefore, by refinancing now before rates increase again you effectively lock in a fixed rate for the term of your mortgage. Now a fixed rate mortgage is a double-edged sword. If rates go back up you benefit. But, if rates fall further you would be paying higher than you have to. In fact, this would have been the reason why you had to refinance in the first place. Overall fixed rate mortgages may not be the most efficient instrument. If rates fall, while in theory you may be able to refinance, the costs associated in the form of legal fees and stamp duty can be significant. These upfront costs may make it prohibitive to refinance even though there could be significant interest savings over time.

There may be a way to avoid this by getting into a floating rate mortgage, which increases or decreases in tandem with market conditions. If rates fall so does the interest cost on your mortgage. On the other hand, if rates increase so does your interest cost. However, if you expect rates to decline, this facility could be useful in that your interest cost is lowered without having to incur the upfront costs of refinancing. The only downside remains the fact that the rate can float up if rates in the market increase. Nevertheless, even this can be hedged to an extent by the use of an interest rate ceiling. While you may have to pay a slightly higher initial rate on your mortgage for this benefit, it provides protection in a rising interest rate environment. Discuss the options with your banker and shop around to get the best deal.

Q. My sister has been investing $100 every month for about two years. I prefer to save when I have some extra cash, some months $200 and other months nothing.
She tells me her regular saving, although small, will grow faster than my casual approach. Is she right?

Amoy, Arima

A. Your sister may be right. It may be better, especially when inculcating a savings habit, to set aside a fixed amount per month. This imposes a discipline on yourself which helps to promote the “staying power” needed to keep dedicated to savings. If an ad hoc approach is adopted it is very easy to drag one’s feet and keep on deferring saving for the future. In such circumstances, the extra luxury goods may become more important than the $100 in savings. Apart from building the habit, your sister may be right about the rate of growth of your savings if a regular amount is set aside. The quicker you accumulate savings, the faster you benefit from the “time value of money” and the “compounding effect”, two very important concepts in finance.

The time value of money means the longer the time period over which you save, the greater is the dollar interest earned. The compounding effect is a related concept, but specifically refers to the ability to keep on building on your initial principal. This arises from adding interest onto your principal periodically thus being able to earn “interest on interest”. This significantly increases the growth of your savings. So work out a budget and determine the fixed amount per month that you can set aside and stick steadfastly to it.

Q. I operate a small business and often get paid a retainer on starting a project. I usually keep the money in my chequing account. A large part of these funds may sit in the account for up to eight weeks. I’m wondering if there is a way to make this money work for me over this short period, yet still be able to draw on it for materials and paying the people I work with?

Rooplal, San Fernando

A. If you run an overdraft on your chequing account, as some enterprises do, your retainer would already be working for you, keeping a positive balance in your account so you don’t have to go too deep into overdraft. This would reduce the exorbitant cost of interest that has to be paid on overdraft facilities. With commercial prime at an average of 11.5% a small business operator just starting off would pay nothing less than 12.5% on a credit line at the bank, which is extremely high given the low rates on savings accounts. If you do not have an overdraft and/or you run a surplus then you would want to generate some interest revenue while the funds are lying idle.

Now, if you have the funds in an overdraft account then if you run a surplus, in most cases, you are earning no interest on your balances. This is because most of these accounts have no “credit-interest earning” feature. This simply means that while you pay interest cost on drawn balances, if you run a surplus and leave the credit line undrawn, these credit balances or surpluses have no interest being earned on them. In order to have surplus balances earn interest, some banks have employed something referred to as “sweep accounts”. As the name implies, whenever there are surpluses in the account these are “swept” into an interest-bearing account overnight and are then re-credited into the chequing account the following day. In this way there is significant flexibility in that you can write cheques, draw on your overdraft and still be able to earn interest on positive balances if and when they do arise. Talk to your banker and work out the best option for you.

Questions can be sent to: PO Box 1830, Wrightson Road, Port-of-Spain. Email:cmmbsecurities@mycmmb.com