Don’t Do These 3 Things When Refinancing Debt: City of Chicago

Chicago River

Decisions about personal debt can be stressful. Your decisions about debt can have an impact on your finances for years into the future. It’s important to take a deep breath and think through your options. Take the time you need to make smart decisions about debt- and avoid these mistakes.

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

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

Chicago has huge liabilities that it is required to pay. The city has 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 has a state-mandated, $550 million payment due in December of 2015 to Illinois. That payment is required to shore up pensions for police and fire pensions.

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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?

New income sources

Chicago is considering new revenue sources, as well as continuing some current cash inflows to pay on the debt. The city is mulling over a publicly-owned casino, as well as instituting a sales tax on many new types of transactions. Property taxes may also be increased.

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

The city of Chicago’s debt rating received 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.

Consider 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 avenue 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.

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Refinancing short-term debt with a long-term loan

Chicago “pushed out” the maturity dates for much of it’s debt. 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.

Have you made decisions about debt that worked for you? I’d love to hear about it. Feel free to comment.

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

Co-Founder: accountinged.com

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20120512 01 Chicago River @ Orleans St.

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