Fixed vs. Variable Rate Loans

Hello! Is there any conventional wisdom about how to evaluate whether a fixed or variable rate loan is the way to go? We're considering refinancing my husband's law loans to a lower rate. The variable rate is extremely attractive (3.065%) but because of the high balance we're nervous to go that route. There is a cap at 8.95%... but what is the likelihood of rates increasing that dramatically? It would be a 10-year loan.

The alternative is a fixed rate loan at 5%. Still lower than we're paying now, which is good, but not quite as low.

Any advice?

Fixed. I've seen too many people bankrupt by variable.

If you run the numbers you might be surprised to find that the fixed rate is only a few bucks a month more. If that's the case you might sleep better.

If not, you have more to think about.

FilmCarp said:
If you run the numbers you might be surprised to find that the fixed rate is only a few bucks a month more. If that's the case you might sleep better.
If not, you have more to think about.

It's $150 a month more.

The 8.95% cap would put the payment at $500 month more, maximum. Which is not nothing, but will it get that high

will your husbands income continue to increase and family expenses remain consistent to absorb an increase over time

If you are not sure a variable is risky

new207040 said:
will your husbands income continue to increase and family expenses remain consistent to absorb an increase over time
If you are not sure a variable is risky

That's a good way to think about it. And I guess the answer is "who knows?" I've always leaned toward fixed but wanted to be sure I wasn't just being overly cautious/paranoid

How variable? Is there a period during which it is fixed? Is there a schedule for adjustments in rate? Monthly? Annually? Are there periodic upwards adjustment caps or just a lifetime cap

Steve said:
How variable? Is there a period during which it is fixed? Is there a schedule for adjustments in rate? Monthly? Annually? Are there periodic upwards adjustment caps or just a lifetime cap

It looks like there is not a schedule, it's tied to the 1-month LIBOR with the ca

There's risk in that particularly because the fed is likely to start raising rates in September.

I vote for fixed. Variable is best for short-term loans. You buy an investment property to flip a year later. That's a scenario for variable rate. Not your scenario. Go with the fixed.

Thank you all for your advice. I did confirm with them that we'd be able to refinance later for a fixed loan, but I think we will likely go that route anyway.

One reason we were considering it is we may consolidate two loans. On one, we have 14 years to go and with the refinance, we'd lose .75% and shave off 4 years with a modest increase in payment. No-brainer there.

The other is currently on a 25-year term at a higher rate. If we consolidated with the first loan, we'd pay it off in 10 years and lose about 1.5%...but the combination would be a pretty big hike, about $500 a month. Doing the variable would make it more feasible but makes us nervous.

So in short, we're just weighing it all to see if we could handle the price jump. It's scary but it would be darn amazing to get out from under the loans in 10 years!! We just have to decide if we can sacrifice enough to do that.

Decisions, decisions...

Right now, it's a fixed rate environment in general. The differential between fixed and variable is small. Traditionally, when it's a variable rate environment, the difference is substantial.

My question is what index is the loan based on? I see the answer is 1 month LIBOR. How often can the rate change? Look at the history of that index in particular. Also consider the impact of the new payment on your total monthly budget.

In 2002-2003 people were getting ARMs (Adjustable Rate Mortgages) where rates were "fixed" for 3,5 or 7 years at a vary low rate and then they became variable against a benchmark such as Libor. Many purchased their homes with these products because interest where the lowest ever, at the time, and nobody thought they would go up that much. Well, 4-5 years later, interest rates were creeping to 6.5% right about the time the teaser rate or fixed rate of the arm expired, and may saw their monthly payments go up significantly although their income had not grown in the same way. This, along with many other factors, caused further strain on the housing market and the issues that we saw in 2008-2009. Variable rates are only recommended either for short term, as stated by Shoshannah, or if you are expecting rates to go down. Right now, although the have been very flat for a very long time, the expectation is that rates will start to go up. When and how fast, nobody knows, but they are the lowest ever. Best to lock a fixed rate. Even if you can refinance later, as rates start to go up, your fixed rate will also be higher than what it is being offered today. So you should do the math under various scenarios. If the rate goes up 1/4 of a point every 3 months starting in September, what will the rate be in 3yrs, 5yrs, 7yrs, and how much that will cost you? As rates start to go up, the fixed rates will go up as well. So you should consider the cost of refinancing at 6%, 7% percent with 3yr, 5yr, and 7yr left vs getting a 5% fixed now. Then it is a matter of which scenario looks best. Rates will move slowly, but once they do they will be hard to predict. If you go with a variable rate I would suggest that you pre-pay the loan. Even an extra $100 per month will make a big difference. Run some calculators to see the impact of the prepayments. The most you can pay up front the better. If you can prepay the $500 that you would save by going with the variable rate you would make a significant dent that could offset an increase in rates.