@financial guys- variable vs fixed on 5 yr refin

[ericn2k3]

I've been paying my loan pretty aggressively and only recently decided to refinance to reduce my fixed 6.8% rate. Going with CommonBond I have 2 options.

5-year repayment:

Est variable: 2.47% $1,826.94/month (max 8.99%)
Est fixed: 3.71% $1,883.78/month

The monthly payment is a non-issue as I'm paying more than that now. I plan to pay off the loan in less than 5 years. What I'm uncertain is the variable rates. I have no knowledge of the market to predict the near future. I could you your advice. Thanks in advance.

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[WVUPharm2007]

It's all a guess. I'd take the fixed.

 

[lord999]

Your question stated a different way is Japan (low, stagnant rates) or Weimar (low rates followed by super, super inflation high rates).

If you had asked the question 5 years ago (2011) variable rates "won" but at a risk point that's pretty risky.

The way to "price" that under classical theory is to look at the 5 year rate as people locking that rate assume that's the highest "best" rate available.

Short versus long bond rate:
https://www.treasury.gov/resource-c.../Pages/TextView.aspx?data=yieldYear&year=2016

Technically, with institutions buying between the 1.8 and 2.3% rate, that's seeming to suggest that the banks think that rates won't increase beyond that spread. Problem is that when banks mess that up, you have a credit crisis. Even with 1% higher, 3.47% is still lower than your fixed quote.

In 2011:
https://www.treasury.gov/resource-c.../Pages/TextView.aspx?data=yieldYear&year=2011

2.3-3.2% were the rates quoted, so if you had "saved" to buy until today as a bank, you lost on the spread (you should have bought in 2011 not today).

Is the lower rate something that you are willing to risk considering this? That's why the banks are loading up on the debt because it's so, so cheap.

I don't have a mortgage anymore, but I still personally would do fixed rate as I don't trust economists very much having to deal with their sensationalism about growth. I also don't consider having a job necessarily a given at this stage in the profession (even though I'm government now).

(Those of you who actually do the math, there is an economics theory called Black-Scholes that posits rate convergence where that argument above does not apply. In practice with the time series evidence, that never worked out and almost collapsed the market via LTCM when those economists tried to put that into practice. Never figured that a revolution would occur...I believe in the classical theory that the interest rate reflects what rational institutions would hedge their interest rates again so someone buying a 10 y bond at 3% does not usually believe that the increase in a decade would be more than 3% + the National GDP growth rate.)

 

[pezdispenser]

You should play around with the various ARM vs fixed-rate mortgage calculators available on the net like this one:
http://www.bankrate.com/calculators/mortgages/compare-arm-or-fixed-rate-calculator.aspx

For that one, ignore the interest only ARM section. I put in:

Mortgage amount: $102,300
Term 5 years (reduce the term to simulate extra payments)
Fixed rate 3.71%

Fully amortizing ARM initial interest rate 2.47%
Months rate fixed: 12 (in reality Common Bond can vary the rate every month)
Expected adjustment: 1.5% (you can play around with this)
Interest rate cap: 8.99%

Click over between view report/hide report and compare the "Total payments" figure. With the above assumptions, fixed rate comes out ahead by around $1700. However, if you want to simulate making extra payments, reduce the term to say, 3 years, which has a total monthly payment of around $3000. Then the variable rate comes out ahead by around $600. So like I said, play around with the term and expected rate adjustment and see which one comes out better.

 

[RPh Who]

If you are already paying more than the required monthly, go with the fixed rate. The only difference is $1,240 per 100k borrowed per year. This isnt a lot of money. If you have a fixed rate dollar denominated loan and inflation really starts to take off, you are further ahead because you are paying the loan back with money that is losing value.

In relation to variable interest rates, remember that student loans are typically libor plus your risk premium. Libor rates are independent of the fed. Libor has been ticking up over the past few months.

Personally, I think we will experience short term deflation followed by significant inflation due to massive expansion of the monetary supply.