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Yesterday we discussed whether the recent action by the Federal Reserve to cut interest rates represents an opportunity for homebuyers to save money by refinancing their homes. Today, we will discuss what the rate cuts mean to your student loans. Unfortunately, after doing some research, we have found that how banks determine the rate as to which they will lend you money for school varies from financial institutions and different lending products. In addition, many other factors are used to help banks set your rates like co-signers, credit history, variable and fixed products, and percentage of origination fee (a percentage of the total amount of the loan). So, stay with us as we plow through the nontransparent world of student loan lending.
What Number do Banks Use to Set Their Rates?
Unlike home loans – where you have a sense of what your interest rate will be by easily checking what the national average is for products like a 30-year fixed loan – student loans use different benchmarks to base their lending. We will discuss three of the main benchmarks used that will hopefully help you get a sense as to whether refinancing your student loans is the right thing for you or not.
1) Cost of Funds Index (COFI)
Currently, my private variable student loan rates are based off the COFI. The COFI is a regional average of interest expenses incurred by financial institutions that is used to calculate variable rate loans. To our knowledge, the COFI rate is a private calculation between banks and is not available to the public. Most lenders readjust your rate quarterly (every three months) based off this average. Most importantly, the COFI is not directly linked to the federal funds rate, which means the index does not move in the same direction as the recent rate cuts. In fact, since January 1, my student loan rates have actually increased. You can easily find out how your student loan rates are set by calling your lender and asking, it worked for me.
2) London Interbank Offered Rate (LIBOR)
Many lenders will use this rate if you decide to consolidate your private student loans with a variable rate product. The LIBOR rate is the interest rate the most credit-worthy banks around the world charge each other for loans. The rate fluctuates throughout the day based on the market, similar to stocks. Most Student loan lenders that set their rates using LIBOR will readjust their rates quarterly, based on the LIBOR rate + an additional percentage depending on factors like if you have a co-signer, how big of a origination fee you choose etc. For example, if I were to consolidate my student loans now my rate would be based of the LIBOR Rate from the start of the new quarter (January 1) which was at 5.12% + 3.14%(call your lender to ask what this additional amount will be) for an interest rate of 8.26%. It is important to remember that the LIBOR rate moves independently of the federal funds rate.
3) Prime Rate 
The prime rate is usually about 300 basis points (or 3 percentage points) above the federal funds rate, which again is the rate that has recently been cut. Some student loan lenders and most credit card companies will use this rate + an additional percentage (based on the same factors listed above) to determine the rate as to which they will lend to you. Currently the Prime rate is around 6% and because this rate runs in sync with the federal funds rate, it is very easy to track. A consolidation that uses the Prime rate will likely be your cheapest current option, given the recent cuts.
What Does All of This Mean, Should I Consolidate My Private Student Loans?
We feel that if your rate is around 7-8% for you current private student loans, you will have a hard time finding a better rate. For those of you with decent credit histories and student loan rates well above 8%, it will not hurt to shop around a little. Keep in mind the different ways banks set your rates as described above, to help give you a sense of how your rates will fluctuate given the economy in the future.
Remember, the lowest rates generally will come with requirements of a co-signer, in addition to an origination fee. Most lenders will only allow you to consolidate your private loans with them once, but you can always use a different lender to consolidate in the future. Also, keep in mind when you consolidate, your loan term with some products will reset you to an additional 20 years. Therefore, if you have been paying your loans for 5 years and you consolidate, you will take the balance you currently have and stretch it out for another 20 years, meaning more interest payments. Just like home loans, don’t be afraid to ask about a fixed rate, generally you will be able to get a fixed rate of about 8.4% with a 1% origination fee and a peace of mind knowing your monthly payments will never change.
Lastly, before you say yes to a consolidation, do the math to determine the origination fee you will have to pay is less than the savings you will acquire with the lower rate. To figure this, take the origination fee minus the yearly amount you will save in monthly payments (click here for a loan repayment calculator) to ensure you will be saving more with the lower rate than you will be paying in fees to obtain the loan. $
At the request of a Milk Your Money subscriber, we are doing a two part series on the pros and cons of refinancing your loans in light of the Federal Reserves recent interest rate cuts. Today, we will focus on refinancing your home loan. Should you take advantage of the rate cuts and refinance your home? Tomorrow, we will do a piece on what the rates cuts mean to both your student loans, what actions should you take? Click here to subscribe to Milk Your Money’s daily posts in your email, so you don’t miss out on tomorrow’s follow-up piece.
What are your Plans?
Do you plan to pay off your mortgage in full? Will you be living in your home for at least another three years? Do you want to pay off your mortgage faster? These are all legitimate questions you should ask yourself before refinancing your mortgage.
It’s important to understand that when you refinance your home with a lower interest rate, the reduction to your monthly payments will not be dramatic, thus the number of monthly payments you intend to make at your reduced rate should equal a higher figure than the fees associated with refinancing. In other words, most banks will charge on average around 2% of the entire new loan in closing cost (similar to the fees you paid when you closed your first home loan). As an example, if you refinance your current home at $200,000 with a savings of $85/month due to the reduced interest rate, you must live in your house for at least 4 years to equal the $4,000 (2% of loan in closing costs) to start benefiting from the refinance. You can now find different refinance packages that will offer lower costs to close as well as no costs, but these packages general come with higher rates. What we can gather from this is, if you do not plan on living in your house for years to come it is most likely not beneficial for you to refinance.
If you are lucky and have some extra money to pay off your loan faster, you can refinance your home at the lower interest rates to switch your loan to lets say a 15-year fixed loan. This will allow you to have slightly higher monthly payments but will save you thousands in long-term interest due to the shorter loan term and the reduced rate. This is highly recommended when affordable.
Do You Currently have an Adjustable Rate Mortgage (ARM)
ARM home loans - which have caused our current credit crisis – are loans where your interest rate will readjust to higher rates due the terms in your current loan, which increases your monthly payments, unlike a 30-year fixed loan. If you currently have an ARM loan on your home and your rate is set to increase in the near future, refinancing your mortgage is probably a great idea. The benefits to this are two fold. First, you can avoid higher monthly mortgage payments by refinancing to the current lower rates and pay off more of your principal with each payment. Second, by refinancing your ARM loan to a fixed term loan, you can rest assured that you can continue to afford you mortgage, which is piece of mind that does not have a price tag.
Do You Own at Least 20% of Your Home?
Private Mortgage Insurance (PMI) is added to your monthly payment if y
ou do not own at least 20% of your home. PMI payments can range anywhere from $100/month - $300/month depending on the size of your loan. Many of you may have piggyback loans, which are loans of two amounts typically one loan for 80% and another for 20% (this loan will most likely have a higher rate and separate terms), this type of borrowing allows you to bypass paying PMI. You may want to consider refinancing your loan if you have a piggyback product if the value of your home combined with your previous principal payments, gives you 20% ownership of your home. This will allow you to cash in on the lower rates as well as combine your loan into one fixed rate loan with no PMI, a win win situation.
Conclusion
Take all of the above into account when considering refinancing your home and remember to look beyond your current lender when you are shopping for interest rates. Other lenders may be able to offer you lower rates in addition to reduced closing costs.
Check back tomorrow when we discuss what the rate cuts mean to your student loans. $
Credit card companies are coming under fire lately, and in our opinion, deservedly so. Credit cards of all kinds are now taking advantage of the 10 pages of fine print you agree to when signing up for a new card, which gives them the rights to basically do whatever they wish to your interest rate. It is not uncommon now for good customers, those that pay their card in full every month on time, to have their rates raised. Sound unfair, well it is. Because of the problems associated with the mortgage mess and even hedge funds, banks are now looking for other ways to balance their books, and they are turning to the average consumer.
Congress is now in tune to the problem and has held various oversight hearings. However, we feel it is unlikely that any major reforms in the industry are likely during the election year, but attention to the issue will only heat up. Half of Americans carrying total credit card debt average around $10,000 each (according to the U.S. PIRG). Because of the enormous amount of debt people are facing in other areas of their life with student loans, ARM mortgages etc., it's hard for anyone to afford jacked interest rates on their credit cards.
Common Practices Credit Cards are Using to Get More From You
Double-cycle billing: This is a practice, which is confusing when explained in plain English, let alone when sifting through the fine print. Here, banks issuing credit cards will charge you interest on the entire amount you charged during a billing cycle, regardless of the amount you actually pay off. For example, if you charge $2,000 one month and pay off $1,900 leaving a balance of $100, the bank will make you pay interest on the full $2,000 in the next month and beyond, until the remaining $100 is paid off.
Universal Default Pricing: This is a practice where banks are taking advantage of good responsible customers. Regardless if you have never missed or had a late payment on your current credit card, companies may now raise the current interest rate on your card if you are late on a completely different bill with a completely different company. In addition, they can raise your current rate if your credit score falls.
Zero-Tolerance Late Payment Policies: Little leeway now is given to customers
from certain financial institutions. You can now be charged the same late fee for being an hour or a day late as those customers who are months late on their payments. Keep in mind that due to the magical fine print you agreed to, any late fees may also result in a penalty rate imposed on your account, which according to CNN can top 30%, which can be applied to not only purchases you are going to make in the future, but also the ones you made last week!
Suggestions
Milk Your Money is troubled by these practices, which are becoming more common, and has a few recommendations you should take as a cardholder to ensure you are not a victim of these rate hikes.
1) Read your statement each month. Look to make sure that the interest rate remained the same from the previous month. Look to see if any fees or penalties were charged to your account. If any of these appear on your statement, call you company and get explanations, you many see these charges dropped, just for asking.
2) Stop using multiple credit cards. The more credit cards you are using, the more likely you are going to "break the rules," with one of the companies. For example, you might go over your credit limit or forget a payment. Focus on using one card and really understand the terms of the card to ensure you use the card only to your advantage.
3) Forget about rewards programs if you are paying interest month to month. Rewards from credit cards should only be taken into consideration for those that are truly responsible with their spending. Rewards average around 1% of your total purchases. This is a number, which is wiped out with one late fee assessed to your account or a month-to-month interest payment. Companies love that people are obsessed with earning frequent flyer miles or any other reward when using a card, many of these people don’t look at their credit card statement, but do look at how many miles they have earned. Money is money, so treat it that way.
4) Call your card issuer and ask for a lower rate. We have stressed this before in an earlier post. Nearly half of the people who call into their company asking for a reduced rate are successful. This is an amazing number! Credit card companies spend so much money marketing their cards and gaining new customers, that once they have you, they don't want to lose you. Take advantage of this and ask for a lower rate today! $
Yesterday we discussed whether the recent action by the Federal Reserve to cut interest rates represents an opportunity for homebuyers to save money by refinancing their homes. Today, we will discuss what the rate cuts mean to your student loans. Unfortunately, after doing some research, we have found that how banks determine the rate as to which they will lend you money for school varies from financial institutions and different lending products. In addition, many other factors are used to help banks set your rates like co-signers, credit history, variable and fixed products, and percentage of origination fee (a percentage of the total amount of the loan). So, stay with us as we plow through the nontransparent world of student loan lending.
Remember, the lowest rates generally will come with requirements of a co-signer, in addition to an origination fee. Most lenders will only allow you to consolidate your private loans with them once, but you can always use a different lender to consolidate in the future. Also, keep in mind when you consolidate, your loan term with some products will reset you to an additional 20 years. Therefore, if you have been paying your loans for 5 years and you consolidate, you will take the balance you currently have and stretch it out for another 20 years, meaning more interest payments. Just like home loans, don’t be afraid to ask about a fixed rate, generally you will be able to get a fixed rate of about 8.4% with a 1% origination fee and a peace of mind knowing your monthly payments will never change.
