The Meaning of “Priority” and the City of Chicago’s Debt Refinancing Mess

I was interested to learn from this Tim Ferriss podcast that, for hundreds of years, the word “priorities” was never used.

Because you can only have one true priority.

It wasn’t until the industrial revolution that the word “priorities” started to be widely used. With so many tasks to do so quickly, people decided that they had multiple priorities….

So, if you’re asking the question: “Should I refinance my house?”, the priorities depend on the cost to refinance homes (the new rate you pay on the debt), and the term of the loan- the time required to pay off the loan in full.

When is it worth it to refinance?

You probably get bombarded by refinancing options in advertisements, just like me. I’m in St. Louis, and Cardinal baseball games are a big local TV draw. We have a mortgage lender who is spending a fortune on ads- and he’s decided to star in each ad himself.

He’s not very good.

In my view, a smart refinance boils down to a simple question: is the total cost of refinancing less than the current amount you’ll pay, if you keep the same loan in place? This is the question that you need to ask your loan officer, and the answer must be clearly started, and there are some traps you can fall into.

Let’s say that your refinancing from a 6% loan to a 4.5% loan, but you’re adding 7 years to the full repayment of the loan. Sure, the interest rate is lower- but what is the total interest paid, including those 7 additional years?

You might not be better off.

I’ve written about stock market risk, confusion about how stocks trade, investment costs, and how stock price volatility is measured. However, making a uninformed decision regarding the cost of refinancing also creates risk.

Sadly, the City of Chicago example

Corporations and municipalities also carry debt, and must make informed decisions about issuing debt. I discuss corporate debt here and here.

The City of Chicago provides a compelling example about debt refinancing. As the Wall Street Journal explained, Chicago converted $674 of variable rate debt into fixed interest rate loans in 2015.

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Do you have the cash flow to pay on your debt?

Chicago had huge liabilities that it was required to repay, and the city had a $30 billion pension crisis at city and public schools. State law requires that the city fund these pension payments for former school employees.

In addition, Chicago had a state-mandated, $550 million payment due in December of 2015 to Illinois. That payment was required to shore up pensions for police and fire pensions.

Now, think about your own situation. If you’re going to take on debt, will your finances allow you to pay on that borrowing? Specifically, will your monthly budget allow you to make those principal and interest payments?

Finding new income sources

Chicago considered new revenue sources, as well as continuing some current cash inflows to pay on the debt. The city mulled over a publicly-owned casino, as well as instituting a sales tax on many new types of transactions. A property tax increase was also considered.

Do you have additional income sources that can help you repay a loan?

Will your credit rating allow you to borrow at reasonable rates?

In 2015, the city of Chicago’s debt rating had experienced a double-downgrade from Moody’s Investor Service. Moody’s, along with Standard and Poor’s, are the two largest companies that rate bond debt. They perform a periodic analysis to determine the ability of corporations and municipalities to repay debt.

When an entity’s debt rating goes down, they must offer investors a higher interest rate to attract buyers. The additional interest costs can be enormous. In one case, Chicago was forced to pay an interest rate of 5.84 percent. If the city’s debt had been assigned the highest (AAA) rating, they would have paid about 2.5 percentage points less on the same debt.

The cost of refinancing depends largely on your personal credit rating: If you need to borrow, can you take out debt at a reasonable interest rate? If not, can you find another option to get where you need to go financially?

Say, for example, that you need a car loan. The interest rate you are offered on a 4-year loan makes the monthly payments too expensive for you. Maybe you lease a car for two years. Once your credit rating improves, you then borrow money to buy a car- and get a lower interest rate.

Refinancing short-term debt with a long-term loan

Chicago “pushed out” the maturity dates for much of its debt. Sadly, there’s a price to be for refinancing short-term with long-term debt. Over time, you’ll pay a lot more interest.

Use this knowledge to improve your personal finances. Try to enter into loan agreements that are as short term as you can afford. Look for a loan that allows you to refinance after a few years. If you can improve your credit rating, you can refinance a longer term debt at a lower interest rate.

Consult with a financial advisor regarding personal finance, investment, and borrowing decisions.

Ken Boyd

St. Louis Test Preparation

Author: Cost Accounting for Dummies, Accounting All-In-One for Dummies, The CPA Exam for Dummies and 1,001 Accounting Questions for Dummies

(email) ken@stltest.net

(website) https://www.accountingaccidentally.com/

(you tube channel) kenboydstl

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