Personal loans for education, autos, and homes mean wading through a sea of financial jargon.
The verbiage tends to be mind-numbing and difficult to comprehend. This is ever-so poignant when it comes to loans that have a variable interest rate because of how they rise and fall.
So, how do you manage a variable interest rate without drowning in an abyss of debt? There are three ways:
- Pay it off faster
- Negotiate a lower interest rate
- Refinance the loan
Plus, you should keep your eye on the market to anticipate trends.
About Variable Interest Rates
Also known as floating or adjustable interest rates, variable interest rates move and shift over time. Variable rates rise and fall due to the performance of a benchmark rate, market rates, or an index.
The activity of the particular index or benchmark will determine higher or lower interest rates.
Variable interest rates are tricky because you can end up paying more money than you can afford or more than the loan is worth. Conversely, you can see lower rates, but these don’t occur as often as higher ones.
Variable Interest Rates and Fluctuation
Most banks use the London Interbank Offered Rate (LIBOR) to lend money to each other and as a benchmark for international transactions.
But, borrowers in the United States can receive a prime rate. This only goes to those who are reliable with an excellent credit score. The Federal Reserve manages, controls and sets the prime rate because they control the money supply.
There are a myriad of ways interest rates can change and fluctuate.
For instance, if you have an 8% variable rate based on LIBOR and it goes down, the interest rate will also decrease. But, if it goes up, you could see your interest rate rise as high as 10% or 15%.
Variable interest rates linked to the prime rate often sit at a certain percentage higher than the benchmark.
As an example, if the interest rate is 5 percentage points more than the prime rate, a prime rate increase to 6% or 7% will make your variable rate go from 11% to 12%.
How to Manage Variable Interest Rates
So, if you have a variable interest rate, you want to skirt the rising tail of fluctuation, so you do not end up drowning in debt by having your monthly payment increase to an unmanageable amount.
The idea is to stay ahead of the game as best as you can.
Pay the Loan Off Faster
The best way to get out of debt with your loan is to pay it off as soon as possible. This is the surest method to manage your variable interest rate so you don’t end up paying more money over time.
You can increase payment frequency or pay more than the monthly payment.
If you’re on a tight budget, take a look at your monthly expenses and determine what you can cut back.
It’s also crucial to stick to your budget and not make any purchases outside of what you need. This way you will be able to increase payment frequency or add more money to what you owe every month.
Open a Savings Account
You could also open an account that earns interest specifically for paying your loan. Now, this won’t be effective right away, but it can be useful later on. This way you can earn a little money on your deposits while they are sitting in the bank.
Setting additional funds aside each month, along with making your payment, will allow you to make a bulk payment down the road.
This will be useful if you want to pay off a chunk of the loan because rates are going to increase.
Negotiate a Lower Interest Rate
Contact your lender to see how you can lower your rate. Sometimes, they will grant you a fixed loan if your credit score is good and you have been faithful with your payments.
Note: this kind of leverage is not a guarantee, but it can’t hurt to try.
Refinance Your Loan
If you can’t manage any of the above options, you can try to refinance it. This means you will take out an entirely new loan and use that to pay off the old one.
You’ll be able to reconfigure the repayment terms and opt for a fixed rate that could be lower than the one you are paying now. You should be able to do this easily as long as your credit score is good or have a reliable co-signer with a good credit score.
This means if you refinance now and interest rates drop or your credit score goes up, you can refinance once again to get an even better interest rate.
Keeping Your Eye on the Market
So you are not surprised when your interest rate goes up, it’s important to keep your eye on national and international markets. This way you can make a bulk payment before they go up so you don’t end up paying more than what your loan is worth.
This means paying attention to the activities and announcements of the Federal Reserve as well as the Treasury to see how the numbers fluctuate.
Also, read the financial section of your local newspaper to monitor current lending trends. Being diligent about this will be to your benefit.
Getting a loan can help achieve a better life. But, you want to be smart about it, especially if you have a variable interest rate.
This means staying on top of and anticipating market trends. It is only in your best interest so you can avoid financial hardship later on.
If you can stay on top of things, you’ll be able to pay off your loan in a reasonable amount of time while avoiding paying more than you can afford. In the event you can’t add more money to your monthly payment, you can try to negotiate a lower rate or refinance your loan.