Anyone have experience with a variable rate loan? Good /bad?

[shopaholic814]

We are looking to refinance our student loans to lower rate loan and have the option of fixed or variable rate.  Let me say that we haven't filled out the credit app yet, just spoke with the customer service rep yesterday.  But we have excellent credit, high 700s/low 800s for DH & I so we should get good rates.  The lowest fixed rate the have (5.35%) isn't much better that the lowest rate we have now (5.5%) and their variable rate is as low as 2.8% for good credit.  We have never done a variable rate loan, for obvious reason.  But we are only considering it now to get these SL's paid off ASAP & pay as little interest as we can so that we can pay them off sooner. 

I want to hear good & bad experiences with variable rate loans if anyone is willing to share.  I want to be informed before going into this.  This scares the living daylights out of me & I don't fully understand it all.

Thanks!

[Bonny]

How long are you estimating it will take you to pay off the loans?

My experience with variable loans is limited to a mortgage that encumbers a condo I inherited from my mother.

Neither DH or I would have ever taken out a variable mortgage. I came of age in 1982 when mortgage rates dropped from 19% to 17%. You don't forget that.

Oddly enough it's turned out to be one of the best loans we've had. The original loan was an interest only fixed rate for five years @ 5.5% which started in August of 2004. Currently at 3% but has been at 2.75%. I suspect the average has been at about 3.5 since I took over the loan in 2008. That's much better than any fixed loan I could have refinanced into as a non owner occupier.

If you're aggressively paying off the mortgage and think you'll have it paid off in less than 5 years you'll probably do better with the variable loan.

[shopaholic814]

Bonny: We will refinance for 5 years. It's our student loans and we should be able to pay them off in less than 5 years if we are able to get the 2.8% low rate. If we do the fixed rate, we will still refinance for 5 years, but it will take us longer to pay off & will spend more on interest. We worry about rates going up in this climate, it looks like they are moving in that direction. Our current highest rate loan is 6.8%, not too crazy high when you consider what we would be refinancing to a fixed rate for. Is it even worth the hassle or the threat of a variable rate going to 21%?

[haapai]

There are things that you can do with amortization tables to investigate the risks and rewards of what you are proposing. 

I suspect that if you gather all those numbers and loan terms together and crank out the tables, you may find the savings minimal compared to the risks.  You might save a couple thousand dollars, or possibly only a couple hundred dollars, but you'd be putting yourself on a treadmill that you can't step off of until the loans are paid off. 

 

[alabamagal]

Is there a limit to the amount that the loan can go up in a year? How much is the total you owe on the loans?

If you are planning to pay off faster you will probably come out ahead. The higher rates ( if they happen and I think they are likely to go up some) will be applied to a lower balance. Interest rates shouldn't go to 19% overnight. You can google historical mortgage rates to see that in the last 30 years the rates usually change by 1% or less. There was 1 year jump by 3% to 17%? back in the 80s.

Just pay the fixed rate amount to your variable loan and you will be ahead even with 1% rate increases every year.

[haapai]

It's definitely possible to construct a debt amortization table that shows how a variable rate debt will behave if interest rates go up a quarter of a point every quarter.  It's intricate, and you have to use a PMT function to recalculate what the loan payments will go up to, but it's definitely doable.  I did something similar when I had variable-rate student Stafford loans that reset interest rates once a year. 

Far trickier is figuring out what to compare the resulting table to and making sure that you are making something close to an apples to apples comparison.  To get an accurate idea of what kind of interest you would pay by making total payments of the same size to your existing student loans requires a lot of work.  You pretty much have to set up side by side amortization tables for your existing student loans and put the excess amount toward the existing student loan with the highest interest rate.  It's quite a bit of work to set up and hard to interpret but if you do so, you may be surprised by how small the savings are compared to what you expected to find. 

A lot of the interest savings that you are expecting to find come from shortening the repayment period of the loan, not from reducing the interest rate. 

I once flipped a credit card debt with an almost infinite payback period for a personal loan with an 18-month repayment period.  The personal loan had a better interest rate but I didn't have any room for life happening while I was making those payments.  You may be considering making a similar move. 

[haapai]

I really want to be blunt here.  The interest rate risk is pretty minimal because the repayment period is short.  You'll definitely find this out if you do some modeling. 

However, the opportunity costs and default risks of committing to a much shorter repayment period are pretty large. 

[Bonny]

Nov 25, 2015 8:24:28 GMT -5 alabamagal said:

Is there a limit to the amount that the loan can go up in a year? How much is the total you owe on the loans?

...  You can google historical mortgage rates to see that in the last 30 years the rates usually change by 1% or less. There was 1 year jump by 3% to 17%? back in the 80s.

Just pay the fixed rate amount to your variable loan and you will be ahead even with 1% rate increases every year.

It never jumped that far. Rates were in the 12% range in 1979 jumped to 16% in April of 1980 and topped out at about 19% in October of 1981 according to this chart from Freddie Mac. A point would buy down a 30 year mortgage about 1/8 %. www.freddiemac.com/pmms/pmms30.htm

I was putting myself through college by selling real estate. I got my license in July 1981. It was a wild time.

It's basically been a long term drop since then.

[haapai]

Hmmm... I misread the OP and thought that the 5.5% rate mentioned was the weighted average interest rate.  It's not.  That's the lowest rate.  I'm guessing that's the rate on loans taken out in 2009-2010 less some discount, although it doesn't look like the usual quarter point discount. 

It's entirely possible that if you compare the variable rate loan to snowballing your existing student loans, you'll pay less interest with the variable-rate loans even if interest rates go up at an insanely quick clip.  You might even pay less interest if you program in the ugliest 5-year increase in interest rates that your baseline index has ever experienced.  I can definitely see that outcome if enough of the loans are at 6.8%. 

I wish that I didn't have to admit that.  I hate having to admit that the savings from refinancing may be quite significant.  I hate the thought of you putting yourselves on that treadmill and not being able to do much of anything in your financial or personal lives until that debt is paid off. 

ETA:  (Whoops, hit "like" instead of "edit".  Can't undo that.)  I really wish that I could show you how I build side-by-side debt amortization charts.  I use separate columns for extra payments (payments above the minimum required) and a separate column to calculate the size of the extra payments.  If you do it that way and stare at it for long enough, it's much easier to see the wiggle-room grow and see when you will be able to change course, make a move, or be able to survive a financial setback.  Most online debt payoff calculators are built differently and don't let you see the wiggle-room. 

[shopaholic814]

Oh, I wish I could totally understand what you all are saying. I'm kind of lost, but I'm reading all of this while at work and I should be working.

We have DH's Masters loans worth       $7,647.47     @ 6.8% FIXED

                                                         $4,829.58     @ 5.41% FIXED

And our combined Bachelors worth     $14,751.97     @ 5.375% FIXED

                                        TOTAL      $27,229.02

All of these loans are Federal Loans, and therefore most banks are not eligible to refinance them.  We have been paying on the Bachelors loans forever & want to get them paid off in 5 years or less. I just filled out the application with a bank that will give us the option to do the loan fixed or adjustable rate & once my husband fills out his portion, we will know out rate.  It does us no good until we know the rate. If they come back with a stupid rate, no concern we will keep paying extra on the smallest loan & bust it out as soon as possible, then go the highest rate.

I gotta get back to work.  I'll re-read all of your posts tonight when I have time to let them sink in, maybe I will understand better when not stressed at work.

Thanks so much for all of the input. I really appreciate it!

[haapai]

The length of the repayment term is also very important.  It's not clear from your posts whether the bank is offering a five-year repayment period or a longer term that you intend to shorten to five by making larger payments than are required. 

Nice things can happen when you make extra payments on variable-rate loans.  Since the required minimum payment has to be recalculated every time the interest rate changes, making extra payments to principal can result in the required payment going down even though the interest rate went up.  This can make paying on a variable-rate loan a lot of fun, provided you have the ability to pay more than the minimum amount. 

Damn, I really hate saying that too. 

I don't particularly like the idea of throwing both of your loans into the pot.  It sounds a lot like something that married folks used to be able to do with federal loans consolidated with the feds.  It caused a lot of problems when folks divorced and it left the surviving spouse responsible for the student loan debt of a deceased spouse.  It was an option that created so much heartbreak and disaster that the feds discontinued the option when they revamped Staffords back in the early aughts. 

You might want to consider getting an IUD and life insurance on your spouse if you go with refinancing.  I wish that I was kidding. 

[shopaholic814]

Well all of our Bachelors loans are consolidated into his name anyway, we did that back in 2001. If something were to happen & we divorced (not that it would ever be a consideration for us-we've been together for 20 years), I would not leave him in the lurch, I would pay my portion of the loans still.  We have talked about increasing his Life Insurance so that it would cover his new loans, my insurance already does considering he makes more money than I do.

If we refinance, we would ONLY refinance to a 5 year loan. No more dragging this out.  We will also pay MORE than the minimum most months now .  Currently our minimum payments are $421 & since paying off our CC debt in the past couple months, it freed up more cash to be able to throw an extra $4-500/mo toward our loans most months.  There are a few months in the summer where we may have to pay the minimums, but for the most part, we should at least be able to pay $250 extra on low income months.  The bank we would refinance with does yearly interest calculations on variable rate loans.

[Bonny]

Nov 25, 2015 14:31:30 GMT -5 shopaholic814 said:

Well all of our Bachelors loans are consolidated into his name anyway, we did that back in 2001. If something were to happen & we divorced (not that it would ever be a consideration for us-we've been together for 20 years), I would not leave him in the lurch, I would pay my portion of the loans still.  We have talked about increasing his Life Insurance so that it would cover his new loans, my insurance already does considering he makes more money than I do.

If we refinance, we would ONLY refinance to a 5 year loan. No more dragging this out.  We will also pay MORE than the minimum most months now .  Currently our minimum payments are $421 & since paying off our CC debt in the past couple months, it freed up more cash to be able to throw an extra $4-500/mo toward our loans most months.  There are a few months in the summer where we may have to pay the minimums, but for the most part, we should at least be able to pay $250 extra on low income months.  The bank we would refinance with does yearly interest calculations on variable rate loans.

Have you considered using a HELOC?

I like the flexibility of being able to pre-pay when able but also being able to pay the minimum in the event of a job loss, illness or some longer term emergency.

[haapai]

If you told us what the total payments were for each of the clumps of loans at the same interest rate, we might be able to crank out some total interest numbers for payments of whatever you choose a month. 

If the minimum payment on the undergraduate consolidation loan (5.375%) is under $281 a month, you'd probably be better off not including it in a refinancing of your other loans at 5.35% fixed.   You'd probably pay less interest by leaving it out, paying the minimum on it, and throwing more at the new 5.35% loan until it was gone, and then doubling back to polish it off. 

[shopaholic814]

We make 2 payments to 2 companies:

The minimum payment for his Masters is $157.35 (even though it's 2 loans, there is one payment made on the same day, but you can make extra payments, which we have done a small amount until recently since the loan started in April 2015) The 2 loans we have in this loan are currently 7647.47 @6.8% & 4829.58 @5.41% for a totally payment =157.35/mo until 3/27/25. I want it gone in 5 years or less.

The minimum payment for our combined Bachelors is now $263.54. The loan was bought out few years ago & the terms were restarted against our consent, but since we now have his Masters Loans to pay, it worked out. The original amount we were paying before it was bought out was about $340 something/mo.  The balances we have here are $5876.83 & 8875.14 @ 5.375% for a total payment of 263.54/mo until 11/14/2028. Again I want it done in 5yrs or less. 

Now that we have freed up a bit of cash each month, we are looking into refinancing this debt, but only if it will help up pay it off sooner. If it's not going to really help us, I'll leave it like it is & just keep throwing money them when we have extra come it.  What is nice is that the 2 bills are due at different times of the month, makes it easier for paying/budgeting. 

[haapai]

I've done some number crunching but don't know how to present the results without making your eyes glaze over.  As Bonny predicted, the 5.4% fixed refi option doesn't do much for you.  It doesn't save you much money and it does lock you into higher minimum payments. 

I've done some analysis of what would happen to your loans under various financing terms with total payments of $600 and $700 a month and it's not particularly motivational.  At those amounts, no matter how the debt is structured, the first 18-24 months of repayment are really, really tedious and unrewarding.  Nothing gets paid off and while your total minimum payments might go down a bit when rates reset, the rates are probably going to reset higher. 

You might want to investigate the lack of short-term victories in all of your options.  A year from now, it might be good to know that none of your other options paid off much faster. 

[haapai]

I'm surprised to find myself saying this, but I'm slowly warming up to the 2.8% variable option.  Even with a 1% increase in the interest rate every 12 months, it's the loan option that results in the lowest amount of interest paid for all of the total payments that I have analyzed.  (I've examined total payments from $600 a month to $800 a month.) 

More relevantly, the 2.8% fixed option seems to give you victories and encouragement much faster than the other options.  None of the other options result in anything getting paid off or any reduction in minimum payments for at least 17 months.  The 2.8% variable option gives a signal the first time that the rate resets.  It's not a big reduction in the minimum payment, but it is some signal that you have made some progress.  Milestones are important when you're paying off debt and the 2.8% variable option seems to have more off them and the first one appears to show up sooner. 

[shopaholic814]

Thanks haapai. DH & I might only refinance his masters loans which are at a higher rate & get those paid off quick, taking the chance out of the interest rate going too high. Then just focus all the $$ on the Bach loans after that, the old snowball method. 

[Deleted]

Personally, I would take a variable loan out again if I wanted/had to. We took a HELOC out in Jan./08 with starting rates of something like 4.75% or maybe even 5% and slammed the payments because like you, we wanted it gone asap. (We bought a 2nd property; a foreclosure; our eventual retirement home...3 more years! Yes!) and surprise, surprise during the few years it took us to pay the HELOC off, the rates actually decreased! 2-3 times! Ending rate was 2.xx%!!

Now I know that that was the time immediately following the housing crash and therefore the reasoning behind the rate reductions, but I highly doubt if you were to take a variable loan to consolidate your SL's.......that you'd see a huge increase in rates in the 5 yr. time frame that you intend on paying them off. I just don't see that happening what with 19Trillion of debt on our books, of which the gov't. can't pay the current interest rates on.....I mean we haven't seen a rate increase in how long? How many years? 7...8...? Unheard of in my almost 60 yrs. on Earth..

Granted, we may see quarter point increases begin next year (Seriously, how long can they continue to keep the status quo?) but I personally don't think you'd see increases of a point at a time. No way, our country's debt just can't handle it. So in 5 yrs. time you may see an increase of maybe 1-2% added total. And it could be less, depending on when they actually start increasing the rate...

....well that's my prediction anyway, fwiw. (which isn't much lol)

Good luck!