Many companies have put old fears of borrowing in a lackluster economy behind, seemingly replacing them with new fears of missing out on the lowest interest rates in generations. This week, Verizon Communications borrowed $49 billion through the sale of 10- and 30-year bonds. That’s a staggering sum and easily eclipses the former record $17 billion bond sale from Apple in April. The question is, are there lessons for the average household in these moves?
With interest rates set to rise in coming years, companies are eager to lock in cheap debt. Verizon will use its borrowed bounty to buy Vodafone’s 45% stake in Verizon Wireless, a move that should boost company earnings. Apple will use proceeds to pay the dividends that have helped push its shares 20% higher. In other words, they have specific needs. “We’re starting to see the animal spirits pick up again,” Schwab strategist Kathy Jones told The New York Times. “Usually, once it gets going it doesn’t let up.”
Driving these spirits is belief in a near-certain significant rise in long-term interest rates as the Fed backs off its stimulus effort known as quantitative easing in the next few quarters. There is also a renewed sense of confidence that the recovery won’t falter. So companies that have a specific use for cash are making the move before costs go up. Consumers would do well to consider the same strategy. As Personal finance blogger Len Penzo writes:
In the grand scheme of things, a household is a business with real assets and liabilities. There are revenues, represented by our household income, and there are non-discretionary obligations such as the mortgage and utility bills. There are also discretionary costs in the form of entertainment, vacations, and other non-critical expenses that require careful analysis and smart decisions.
True, households do not produce goods or services; they don’t pay a dividend (too bad) or answer to shareholders (probably Ok). But I’d argue that they are in the business of generating happiness and security and must answer to the members of the household. So they have a mission and smart borrowing can play a role. This is especially true as it relates to mortgages. “Anybody who’s borrowing money should borrow out for a long period of time,” Warren Buffett said in May. “And if you ever want to get a mortgage, today is the day to get a mortgage.”
Like so many others, Buffett expects the cost of money to rise appreciably in coming years. Locking in a 30-year fixed rate mortgage today to buy or refinance a house is the equivalent of Verizon selling 30-year bonds to buy the part of its wireless business that it doesn’t already own. So, what are consumers doing? Mortgage applications dropped 13.5% the first week of September. Refinancing activity is so slow that banks including Citi and Wells Fargo are closing offices and laying off staff.
The recent lull follows blistering activity in the spring, when many homebuyers acted quickly—precisely to lock in mortgage rates at historic lows. It was a smart move. The average 30-year fixed-rate mortgage has jumped to around 4.7% from 3.3% in May. The best news of all: 90% of new mortgages are at a long-term fixed-rate. We heard you, Warren Buffett, and have locked up a great rate for years to come.
Yet the end-of-summer slowdown may suggest that individuals are afraid of interest rates at this new modestly higher level, which is not how the folks at Verizon feel. Perhaps, they are looking at where rates are headed—not where they have come from. Their best judgment is that rates are going even higher. If that’s the case, this is still a great time for individuals lock up funds—as long as you have a specific need.