[How Much] Should I worry about variable rate student loans?

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[How Much] Should I worry about variable rate student loans?

Postby guitarguy » Wed May 08, 2013 12:50 pm

We have roughly $35k left total on 4 private student loans, all variable rates from 2.2 ~ 3% (prime minus some small %, can't find this info on the website for whatever reason).

Our only other debt is $99k mortgage @ 5.125% fixed. I have investigated refi's multiple times and unfortunately had zero luck. We have an FHA loan with right around zero equity (I know...I know...but that's the spot we're in). According to mortgage companies there has to be a minimum monthly payment reduction to do an FHA streamline refi, and since they doubled the MIP rates since we initiated our loan, the monthly payment reduction would be close to negated by the higher MIP rate. Therefore refi, as far as I can figure out, isn't an option.

Up until now we have been paying down the student loans with smaller balances (most with 6.x% rates). With those gone to start 2013, we stopped prepaying any debt and started banking the money we were throwing at it. We're trying to start a family now, so we're anticipating a significant drop in income before long, and we figured saving some extra cash would be a good thing. Once we have things figured out, we can always make a big payment on debt or utilize the money elsewhere (home improvements a likely candidate for at least some of the savings). Once my wife is situated with her switch to part (or no) time working, and our income is again stabilized, we can make some decisions.

1. Given our uncertainty in the coming year (or hopefully just months), is stopping debt prepayment and saving the extra instead a good plan?
2. When we do decide to start prepaying debt again (after income changes are sorted out, when we can come up with a sustainable plan) should we focus on the loans or the mortgage? My inclination is the mortgage at least to the point where we can get rid of the MIP altogether (will take about $20k of payments), but the only thing is the variable rate on the loans is scary. Should I worry about prepaying the mortgage with student loans having these variable rates?

A couple of asides: We contribute to 401k accounts enough to max employer match, and also maxing 1 Roth IRA. We're planning on keeping this up while also working on eliminating debt. We're also saving for our next car purchase. As important as getting out of debt and retirement planning is to us, saving enough to make sure we don't need to take on any more debt is also important.
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Re: [How Much] Should I worry about variable rate student lo

Postby guitarguy » Thu May 09, 2013 10:10 am

No thoughts on prepaying mortgage with higher fixed rate vs. student loans with lower, but variable, rates?

:?
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Re: [How Much] Should I worry about variable rate student lo

Postby damjam » Thu May 09, 2013 1:32 pm

How much "extra" money do you have to work with each month?

How big is your emergency fund now?
If I were about to loose a significant portion of my income I would want enough saved to cover that shortfall. How close are you?

What amount of time is left on your mortgage?
Although in the long run it may save the most money if you pay down the mortgage first (or the student loans), you need to consider the cash flow issue.

In answer to your question "How much should I worry about variable rate student loans?." I just don't know,my crystal ball is cloudy. In addition your situation seems a little more complex than that single issue.
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Re: [How Much] Should I worry about variable rate student lo

Postby inbox788 » Thu May 09, 2013 1:44 pm

guitarguy wrote:We have roughly $35k left total on 4 private student loans, all variable rates from 2.2 ~ 3% (prime minus some small %, can't find this info on the website for whatever reason).

Our only other debt is $99k mortgage @ 5.125% fixed. I have investigated refi's multiple times and unfortunately had zero luck. We have an FHA loan with right around zero equity (I know...I know...but that's the spot we're in). According to mortgage companies there has to be a minimum monthly payment reduction to do an FHA streamline refi, and since they doubled the MIP rates since we initiated our loan, the monthly payment reduction would be close to negated by the higher MIP rate. Therefore refi, as far as I can figure out, isn't an option.

Up until now we have been paying down the student loans with smaller balances (most with 6.x% rates). With those gone to start 2013, we stopped prepaying any debt and started banking the money we were throwing at it. We're trying to start a family now, so we're anticipating a significant drop in income before long, and we figured saving some extra cash would be a good thing. Once we have things figured out, we can always make a big payment on debt or utilize the money elsewhere (home improvements a likely candidate for at least some of the savings). Once my wife is situated with her switch to part (or no) time working, and our income is again stabilized, we can make some decisions.

1. Given our uncertainty in the coming year (or hopefully just months), is stopping debt prepayment and saving the extra instead a good plan?
2. When we do decide to start prepaying debt again (after income changes are sorted out, when we can come up with a sustainable plan) should we focus on the loans or the mortgage? My inclination is the mortgage at least to the point where we can get rid of the MIP altogether (will take about $20k of payments), but the only thing is the variable rate on the loans is scary. Should I worry about prepaying the mortgage with student loans having these variable rates?

A couple of asides: We contribute to 401k accounts enough to max employer match, and also maxing 1 Roth IRA. We're planning on keeping this up while also working on eliminating debt. We're also saving for our next car purchase. As important as getting out of debt and retirement planning is to us, saving enough to make sure we don't need to take on any more debt is also important.


1) Yes. Don't plan any expenditures when you have so much uncertainty. Doesn't sound like you have any savings, so NO HOME IMPROVEMENTS, NO NEW CAR PURCHASE until things clear up and you have a firm footing. You appear to be overextended. What are your current incomes? Emergency cash? Budget and disposable income? How much have you banked since you changed your payment strategy in how many months?

2) The variable student loan should be ok for the next couple of years, but unknown after that. If the interest is tax deductible, then it's not too bad to carry it out a few years. Without tax deduction, it's about the same as your mortgage with a tax deduction. Personally, I'd take a chance and pay down the mortgage, but that's a conscious choice knowing that variable interest rates could rise, and you could be in a tough spot in 2-3 years. I think the chance to refinance in the near future is worth the adverse risks. Window on low interest may start to close soon, so every dollar counts towards increase that percentage equity you need.

Just some rough estimates given limited information, but I wouldn't begin to think about spending anything until there was at least $15,000 in emergency cash and $30,000 in savings and investments to pay down student loan. It's possible interest in 2+ years time spike up due to inflation. I don't think you'll get there any time soon.
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Re: [How Much] Should I worry about variable rate student lo

Postby guitarguy » Thu May 09, 2013 3:51 pm

Thanks for the replies. I do realize the situation is more complex than just student loans vs. mortgage, so thanks for your input. I didn't mean to make our situation seem so dire. :oops:

Current E-Fund is $10k, between 3.5 and 4 months expenses. We're pretty comfortable with this number.

"Extra" money each month that goes into savings or debt prepayment ranges from $1000 to $1500 (my side income as a musician is variable). Typically, we have been doing:

- $500/m towards debt prepayment (or now, savings). Currently $4000 extra banked on top of $10k E-Fund.
- $600/m savings for our next vehicle purchase (which will ONLY happen when need be. We hope to get about 2 more years out of one vehicle and 7 more or so out of the other (both at a minimum). The reason we were setting aside this much for our next car purchase is to build it up somewhat quickly. Currently it stands at only $2400 since we bought my wife's Civic late last year.
- $200/m for things that need to be done around the house (gutters, etc). Current balance is just $200. Recently we had to tap this savings account to redo our shower and fix some old water damage behind the crappy old tile. Spent about $1200 or so for this.
- $100/m in a vacation fund that we tap into annually. If extra expenses come up or my varying income is on the low side for a month, vacation and home improvement savings are the first (and typically, the only) places we have to reduce savings that month. Current balance is $0...we leave for our anniversary vacation tomorrow morning.

* Also keep in mind all of our savings is only earmarked for these things; we can always adjust on the fly and use all of it as an E-Fund if a serious situation arose.

Income wise, I'm the primary earner in our family at ~$64k (plus variable income on the side...maybe $12k or so). Wife makes around $22k a year in a retail job. Our monthly income loss will be $1300 or so (her current take home) at the most if she quits work altogether, which she doesn't expect or want to do. She wants to continue working a couple days a week if possible. But with a new baby.....we'll have to see on that. We do have access to free daycare (Grandma can't wait :D ) so I think wife working a day or 2 a week is pretty reasonable to count on. I said 'significant' income reduction, but I don't expect to have a serious shortfall even if she quits working altogether since her income essentially equates to our "extra" money each month. Our shortfall will come in the way of not being able to continue to put as many dollars toward paying extra on debt and saving for things like vehicles, house stuff, and vacations.

Roth balance is large enough that about $15k could (at absolute last resort) be tapped to pay down student loans if rates really spiked high.

We are able to deduct the student loan interest. For the past 3 years (since we got married) we get more from the standard deductions than itemizing and taking mortgage interest deductions. Filing for 2013 may be different as we have quite a few charitable donations to add to the mix which should take itemizing slightly above the standard deduction.
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Re: [How Much] Should I worry about variable rate student lo

Postby G-Money » Thu May 09, 2013 5:31 pm

Assuming you're comfortable with the level of your liquidity and ability to weather a financial emergency, I would pay extra towards the mortgage. Having a 5%+ mortgage is expensive. Prime rate would need to jump about 3% for the after-tax cost of your student loans to exceed your mortgage (which you apparently aren't deducting). Plus, the faster you pay down your mortgage, the sooner you'll be able to refi. I would revisit the strategy once I refi'd to a lower rate or if rates spike so much that the student loan rate exceeds the mortgage rate.

But if I were in your shoes, I would probably just build up my reserves in anticipation of a growing family and potentially shrinking income.

Good luck.
Don't assume I know what I'm talking about.
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Re: [How Much] Should I worry about variable rate student lo

Postby damjam » Thu May 09, 2013 11:17 pm

guitarguy wrote:Income wise, I'm the primary earner in our family at ~$64k (plus variable income on the side...maybe $12k or so). Wife makes around $22k a year in a retail job. Our monthly income loss will be $1300 or so (her current take home) at the most if she quits work altogether, which she doesn't expect or want to do. She wants to continue working a couple days a week if possible. But with a new baby.....we'll have to see on that. We do have access to free daycare (Grandma can't wait ) so I think wife working a day or 2 a week is pretty reasonable to count on. I said 'significant' income reduction, but I don't expect to have a serious shortfall even if she quits working altogether since her income essentially equates to our "extra" money each month. Our shortfall will come in the way of not being able to continue to put as many dollars toward paying extra on debt and saving for things like vehicles, house stuff, and vacations.

Sure your wife's income is your "extra" right now. What about the cost of the baby?
I may have misinterpreted your post but from what I read I see the following:
If your wife continues to work 1 or 2 days a week that money just goes straight toward paying for baby stuff. If your wife does not continue to work, you will be in the hole every month paying for baby stuff. The end result is you will not be doing any saving and possibly going into debt once the baby arrives.
Have you been tracking your spending? Is there more wiggle room than you have let on?

I would definitely bank your savings for the time being. You could always pay down your mortgage once you have lump big enough to qualify for a refinance. This will give you the greatest flexibility. You'll have extra cash when the baby arrives. This will be needed because your wife will likely need/want 4-8 weeks off after childbirth. The more you save the more time off you can afford for your wife.
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Re: [How Much] Should I worry about variable rate student lo

Postby guitarguy » Fri May 10, 2013 10:28 am

damjam wrote:Sure your wife's income is your "extra" right now. What about the cost of the baby?
I may have misinterpreted your post but from what I read I see the following:
If your wife continues to work 1 or 2 days a week that money just goes straight toward paying for baby stuff. If your wife does not continue to work, you will be in the hole every month paying for baby stuff. The end result is you will not be doing any saving and possibly going into debt once the baby arrives.
Have you been tracking your spending? Is there more wiggle room than you have let on?


Yes, we meticulously track spending.

If my wife were to slow or stop working, there are additional areas where we'll have expenses cut. First off, about $200/m on fuel savings from her no longer having to commute. Eating out, date nights, entertainment, etc, usually $150-200/m or so, will be drastically reduced. I'm sure we could find more, but that's a pretty significant amount right there off the top of my head, without even looking at our budget. We can also adjust income tax withholding, as right now we avg about a $2500 refund annually. (I know this is a questionable decision, but it's a concious one...due to my side income fluctuations.) I'm also up for a promotion which will net me a good raise. I realize nothing is guaranteed but it's looking very good to happen in the next few weeks. We also have a mother load of baby supplies (furniture, clothes, etc etc) boxed up and waiting for us...different family members recently had a boy and also a girl and can't wait to dump all their crap on us. I realize that's not guaranteed as well...but again...it's looking good.

Although I know things will be tighter, I'm not worried about covering bills or going into debt.
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Re: [How Much] Should I worry about variable rate student lo

Postby Caduceus » Sat May 11, 2013 6:30 am

A good part of your question is about hedging against a rise in the variable rate of your student loans, but since we can't predict when or by how much rates will rise in relation to the 5% mortgage you are carrying, this is a tough question to answer. The only question we can ask is how much you are paying for "protection," which in this case refers to the optional value of your cash.

The most optimal present solution would be to direct all your income to paying down the mortgage note, but this leaves you exposed to fluctuations in your variable-rate loans. So if we assume that this option is off the table, another way of looking at your situation is to quantify the value of the optionality of your cash specifically as a hedge against your variable-rate loans. At current rates, $10,000 pushed toward your student loans only saves you about $150 compared to keeping it in cash (assuming cash earns 1% in a CD, and your variable-rate student loans are at 2.5%). Is the flexibility to deploy this $10,000 worth $150 to you every year? To me, this seems like fairly cheap "insurance" for your situation, and if I were in your position, I would beef up my cash cushion over the next year to an increased targeted level and direct remaining discretionary income to pay down the fixed-rate mortgage, leaving the student loans as they are for now. Increasing your cash cushion would mean that if your variable-rate loans spike, you have the option to immediately pay down a good portion of it, but in the meantime, you are free to earn the excess "return" from your remaining income by paying down the higher mortgage note instead of your student loans.

My sense is that a larger cash buffer than you now have would be entirely reasonable during this transitional period, as other posters have also suggested. Good luck with whatever you decide!
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