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rosarugosa
2-10-11, 5:12am
We are carrying some debt on our home equity line; it is our only debt. We are currently on track to pay it off in 3 -4 years. We are paying a fixed rate of 6.9%, but we have the option of converting it over to a 3% variable rate. We've always been a bit leery of variable rates, but I'm seriously considering it, because whatever we save on interest we could snowball into the principle.
So who has a crystal ball? When will rates start to rise, and how quickly? Would you stick with the known quantity of the high fixed rate, or go for the riskier proposition of the variable rate?

RosieTR
2-10-11, 8:54am
How variable is the rate? Instantly variable or structured somewhat like ARMs, stable for a few years then variable? Variable for chunks of time, like adjusting every 3 mo, or 6 mo or year or what? If you do convert, are there fees associated with this? Have you calculated how much less time it would take to pay off the loan given lower interest rates? You may also have to consider that if you pay more of the principal in the next year (when interest rates are unlikely to shoot up to 6.9%) and then interest rates rise, you'll have proportionally less of the loan to pay at the higher rate. For example, say you have $12,000 to pay off. You plan to pay it in 4 years, which means the average you'd pay off is $3,000/year. However, you'd pay less principal in year 1 vs year 4 due to amortization. This means you might pay off roughly $2000 of principal the first year, but $3500 the last. This means you're paying interest on, say, $10,000 at the end of the first year but interest on $3000 at the end of the third year. I'm doing rough numbers but you'd have to play with an amortization calculator to figure out your different scenarios. Check Bankrate.com for some, or search google. Extremely rough numbers example: 6.9% interest on $12,000 + 6.9% interest on $3500 is a little over $1000. 3% interest on $12,000 + 9% interest on $3500 is close to $700. Personally, I doubt the government is going to increase interest rates such that mortgages are 9% in the next three years, since at that point we'd be just barely back to a "normal" housing market at best, and quite possibly still in some foreclosure nightmare market. With a short time frame, continued low interest rates even for 2 years would probably make a variable better for you, but keep in mind fees may make a huge difference. In the above (very rough sketch) scenario you'd lose money converting over if the fees were more than about $300 (I didn't include guesses for intervening years which would change things, and different rates of interest rate rises would make a difference as well). At one point we looked into refinancing and the fees made it such that we wouldn't break even for 5 years, which wasn't worth it to us. Unfortunately you'll have to run the numbers yourself for your particulars. I'd suggest running a few different scenarios, ie interest rates start rising next year pretty fast vs don't rise next year but rise quickly after that etc. You're likely better off if the interest rate adjusts more slowly as well-every 3 or 6 months rather than every month. If you get a tax deduction on your interest payments, you'd want to take that into account when considering fees as well, since those are not likely to be tax deductible (unless they roll them into another loan, which has its own issue b/c now you're paying interest on fees).

rosarugosa
2-11-11, 4:56am
Rosie, Thanks for taking the time for such a well considered response! I obviously need to play with the numbers a bit, but some of the relevant variables I hadn't mentioned are:
no fees to convert
rate can change from month to month
we no longer pay enough interest to itemize on our taxes; this year, the standard deduction was more than our itemized deductions would have been.

Float On
2-11-11, 9:35am
If the rate can change from month to month - don't do it.

freein05
2-11-11, 11:44am
Coming from an exbanker. The bank is in the business of maximizing profits so it is betting interest rates are going to go up over the next few years. So by getting you to go for variable rate it is maximizing it's profits.

I would agree with the bank. We are probably at the low of interest rates and there is no where to go but up.

Edited to add: The Feds use interest rates to control the economy and inflation. They drove interest rates down fast to try and get the economy going. If there are any signs of inflation the will drive up interest rates real fast to control inflation.

rosarugosa
3-28-11, 2:47pm
An interesting follow-up: we got a call from our bank last week, and they told us we could convert our loan to a fixed 3.75 interest rate, with no fees or costs. It sounded too good to be true, but we went to the bank yesterday and executed the necessary paperwork, and now we owe the same amount of principal but at a much lower rate of interest (fixed). We can still prepay without penalty, so there was basically no downside. Will wonders never cease :)

jennipurrr
3-28-11, 3:45pm
That is great to hear!

RosieTR
3-29-11, 10:16am
This happened to us when the Feds first started dropping interest, which contributed to the housing boom/bust. Near as we could figure, the bank was afraid we'd jump ship to another, and offered us a preemptive refi for no fees. At that time we converted from 30 yr to 15 yr because it was like $30 more a month after the interest rate change. Glad you got a great deal, Rosarugosa!