Applying corporate lessons to the family budget
By Greg McBride, CFA • Bankrate.com

This time of year coincides with the quarterly corporate earnings announcements and the flood of annual reports in shareholders' mailboxes. Along with them come the carefully buffed official pronouncements from company officials about how their firms are strengthening their respective balance sheets.

Though skeptics may roll their eyes, this is much more than just putting a positive spin on three years of declining stock prices, poor profits and continued job cuts. Many of the choices made now will produce benefits for years to come. Best of all, consumers can mimic these moves to better prepare for future prosperity.

Although households do not prepare formal statements for filing with regulators, many principles are the same. What lessons from the corporate arena can consumers apply to repair their household balance sheets?

A common thread in the corporate and consumer sectors has been the refinancing of long-term debt at lower interest rates.

The government and corporations alike have taken advantage of the lower interest rate environment by refinancing their long-term obligations at lower interest rates, cutting interest expense for years to come.

Homeowners have been riding the mortgage refinancing wave continually over the past two years. Many have refinanced on multiple occasions as rates dropped to new lows, each time securing a better mortgage rate. The effect is immediate and ongoing. Monthly savings begin to tally from the start, creating extra room in the household budget that can be put to other uses. This windfall of extra cash is widely credited with boosting consumer spending during an economic downturn. The extra breathing room in the monthly budget continues for years to come, in good economic times and bad, until borrower and mortgage do part.

But what is a homeowner to do with the immediate savings, other than spending frivolously? After all, corporate America has yet to go on a spending spree to upgrade technology and expand operations. In addition to refinancing long-term obligations, strengthening the corporate or household balance sheet also entails paying down high interest-rate debt. Accelerating repayment of such obligations produces even greater flexibility in the future, as the only obligations remaining are those at the very lowest interest rates.

For consumers, this means retiring high interest rate credit card debt and personal loans, a task that is helped along by the current low level of interest rates. Borrowers repaying such debt have the wind at their backs, as more of each dollar is applied to the principal at low interest rates. This effect snowballs as the balance on which interest is calculated in subsequent months declines faster. Working to retire this high-cost debt at a time of low interest rates is akin to making hay while the sun shines, just as waiting until an environment of higher interest rates prevails means working against a stiff headwind.

What about those borrowers who have already dispatched of the onerous credit card debt? How can the extra cash from refinancing be best deployed? Companies talk of enhancing liquidity, which for consumers translates into building an adequate emergency fund. Stuffing cash into a low-yielding savings instrument may seem counterintuitive in this era of record-low interest rates. However, check out Bankrate's list of high-yielding money market accounts to earn a return that is better capable of staving off the erosive effects of inflation. Holding cash for a rainy day becomes less fruitful if the purchasing power of those dollars declines over time.

Also, don't look at this cash reserve in terms of the nominal interest that is being earned. Instead think of this reserve as a buffer from incurring additional debt should unexpected financial circumstances arise in future years when interest rates are higher.

A final glaring sign of the economic times is cost-cutting. Anyone spending time in longer lines at the store or more time on hold waiting to speak to a live person, can attest to cost-cutting measures now being implemented. Many households have undertaken similar initiatives by eating out less, shopping at discount retailers or consignment shops and postponing vacations.

Whether a large multinational corporation or a newlywed couple, spending less isn't just a survival tactic in tough times. The habit of holding expenses in check means even more is left over when prosperity returns.

Greg McBride is a financial analyst for Bankrate.com.

For advice regarding your specific situation, please e-mail one of Bankrate.com's Q&A experts or visit the Personal Finance Advice channel on Bankrate.com.