Episode 42: Refinancing Ladder Approach

Using the refinancing ladder strategy can help student loan borrowers get out of debt much faster. In this episode, learn how the refinancing ladder works for refinancing student loans — and how to decide if refinancing is right for you.

In today’s episode, you'll find out:

• What is the refinancing ladder strategy?
• When is refinancing a good decision?
• Why you shouldn’t refinance federal loans too soon
• What, exactly, is student loan refinancing?
• How student loan refinancing differs from other refinancing
• How Student Loan Planner®’s cash-back bonuses work
• The differences between short-term and long-term refinancing
• How to calculate your payment with various loan terms
• How many times do people generally refinance?
• How to use the refinancing ladder strategy
• Should you go with a variable or fixed rate?
• How historic refinancing rates compare to the rates of today
• How variable rates are calculated
• Why don’t more people refinance their student loans?
• Why putting off your financial health is unwise
• How lenders profit from borrowers who don’t know to refinance
• Who should and shouldn’t refinance their student loans
• Benefits of using the refinancing ladder with cash-back bonuses

Links mentioned:

• StudentLoanPlanner.com/Voicemail
  

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Episode 42 Transcript

Travis Hornsby [00:00:00]Hey, y'all. So today, we're going to be talking about a little-known refinancing strategy that could save you thousands and thousands of dollars. And more importantly, give you a lot of peace of mind on the road to getting to zero debt.

Travis [00:00:13] So you know me. You know me if you've listened to this show for a little while. You know that I really do like forgiveness in certain situations. I think it's wonderful to optimize your loans to be forgiven, to get the maximum benefit from these federal programs so that you don't pay any more than you need to pay.

Travis [00:00:29] That said, I also have to admit that it's super fun to celebrate paying your loans off in full. I don't know if any of y'all saw it, but there was this YouTube video of this woman who paid off $220,000 of student loan debt, and she literally danced around for, like, five minutes in a purple spandex suit. So, as much as I get excited about people putting away money into their, you know, their mutual funds, their investments, their retirement savings, I have yet to see anybody dance around in a purple spandex suit to celebrate a certain net worth milestone with their assets at Vanguard.

Travis [00:01:00] The reality is, is that paying down debt makes you feel really good because it's this thing that you have an ending point. You're working towards this specific goal. And you get to that point of zero, and then you're done. And there is something psychologically that's very appealing to that.

Travis [00:01:15] And I just want to make sure that we don't put too much stock in refinancing, that we don't overvalue it, because that's a psychological error. That's a behavioral bias that we have to overcome. Because we humans are very, very focused on our emotions, and we make a lot of decisions based on emotion instead of logic. And that's just everybody. That's what the whole field of behavioral economics basically says, is that we're not nearly as rational as we think we are.

What is the refinancing ladder strategy?

Travis [00:01:40] So, if you think about that and if you think about the implications of that, then there are a couple of things that you really need to think about when you are considering refinancing. So, one of the first things you have to figure out is what refinancing term do you choose?

Travis [00:01:54] To introduce today's idea for today's episode, I'm going to give you a little bit of a little story here. Recently, I visited my folks — my parents — and they had some work for me to do. How many of you have ever visited your parents, and then they've got some sort of big chore for you to do as soon as you get off the plane? Right? So, my parents needed some help with — one of their rental properties had a bunch of leaves on the roof. There is basically this giant oak tree above one of their little rentals, and it throws off a bunch of leaves on there.

Travis [00:02:25] And my parents are very salt-of-the-earth kind of people. They like doing stuff themselves. And they really have no business climbing up on roofs now that they're getting a little bit older, and so they asked me to do it. I wanted them to just hire somebody that's licensed and certified and has safety equipment — all that stuff. But they said, “Go ahead, and you do it, Travis.” So I did.

Travis [00:02:44] And so I climbed up on this roof with this blower, and I had to blow off all these leaves. And so then I had to come off of the roof, and I had to walk down a ladder. And so that's where the term refinancing ladder — where I kind of came up with it — is when you come off of the roof, you start off at the top rung when you're walking down. Right? Or close to the top of the ladder is where you start walking down.

Travis [00:03:05] Now, if you do a 20-year term, you're starting at the top of the ladder in terms of how long it takes you to get down to the bottom if you just keep doing these standard fixed payments. If you do a 10-year term and you're starting halfway down the ladder but you're having to make, you know, much, much higher payments — And then if you do, like, the bottom of the ladder — you're doing, like, a five-year term — you're paying huge payments to get rid of your loan at a super-fast rate.

Travis [00:03:27] And I realized that a lot of people were making mistakes because everybody wants to pay their loans off right away when you want to pay them off. Right? So, a lot of people have this behavioral bias where they will sign up for a five-year or seven-year term right off the bat because they want to get rid of their debt, and that's just the logical one because it's the lowest interest rate. But that's not necessarily the right thing to do for a whole lot of situations.

When is refinancing a good decision?

Travis [00:03:49] Here's some high-level stuff about refinancing and when it's appropriate: So, if you have private student loans right now — private loans meaning they're owed to a private entity. That could be another refinancing company that you already refinanced with. That could be private loans that you started out with — when you went to school, you took out the private loans in the first place, you know, to Sallie Mae or somebody like that.

Travis [00:04:08] And then whatever it is — if you owe loans to a private lender instead of the government — you should always, always, always try to refinance those, except in some rare cases. Like, you know, you haven't made payments in seven years and you might be able to settle it. So, if you are not in default, if you're making good payments on your private loans, you always need to be shopping for lower rates on those probably at least once a year just to see what's out there.

Travis [00:04:31] Now, obviously, I realize you have better things to do with your time than just check, you know, loan rates on the internet. But that said, I think it's a good idea, especially if you owe more than $50k of private debt, to generally check those rates somewhat frequently. Like, once a year, once every two years — just to make sure that you're not way overpaying on your interest rate.

Travis [00:04:48] So, that's private loans. Always refinance them if you can, if you can find an interest rate that's low enough to make you feel comfortable actually taking the plunge and doing it.

Travis [00:04:56] For federal loans, you need to be rock-solid financially to justify refinancing them. So, let me give you an example of this. If you do not have an emergency fund, if you are not contributing pretty close to the maximum in retirement savings and if you are not putting away money into a brokerage account or mutual fund account on top of that, then I don't personally think that you have a basis to justify refinancing your federal student loans.

Travis [00:05:19] So, the reason for that being is, if you have a big contribution going to retirement and if you have a lot of money going away into investments and you also have a big emergency fund, then if the economy turns south, you could always cut back your retirement savings and your brokerage account amount down to, you know, a 5% retirement level and still get your match. Right? So you have automatically built in a cushion to protect yourself against any negative downturn situations.

Travis [00:05:44] And that's what I'm really worried about. If there there's anything about Student Loan Planner® that keeps me up at night, one is that the fact that we do have all these refinancing bonuses on our site where, you know, some of you could potentially be refinancing. And there could be a recession a year later. And then you could struggle making the payments, and then you could think, you know, “Oh, woe is the day that I found that Student Loan Planner® site.” Right? That's what I really want to try to avoid because I want to always try to act in your best interest.

Travis [00:06:06] So conflicts of interest are unavoidable in pretty much anything, but it's just how you manage them and if you try to do it ethically. Right? So, that's kind of the way I try to do this, is I think it makes tons of sense to refinance if it's the right thing to do because you know that you're going to pay your debt off to zero. You know that forgiveness is not going to help you because you're going to make too much money. Right? Because then you're just paying 4% or 5% to a private lender by virtue of you being a better credit risk compared to paying the government 6%, 7% or 8% and giving them extra money for no reason.

Why you shouldn’t refinance federal loans too soon

Travis [00:06:34] If you think about refinancing, here are some cautionary tales of people that refinanced their federal loans maybe a little bit too soon. So, one situation: I had a dentist who refinanced to a seven-year term and had to pay about $6,000 a month for a required payment. And this dentist was making good money — like, $250k, $300k.

Travis [00:06:50] But then when that dentist went to get a mortgage for a house, the percentage of his income that would be going towards debt — you know, his student loans, then practice loans and mortgage amount — that was going to be over their maximum required — or maximum limit of 45% of take-home pay to debt or something like that. And so they said, “Well, we can give you the house but only if you refinance to a 15-year because that gives you a low-enough payment.” And then, so he was just scrambling to try to find a place to refinance to a higher rate at a 15-year term just so that he could be able to afford his mortgage payments. That's obviously not a good thing.

Travis [00:07:26] Had a couple other cases where we've had some people trying to get practice loans for various things. And then they haven't been able to get those because of doing too aggressive of a refinancing for their mortgage. As a general rule, no matter how big the balance is, I've never seen somebody get denied a mortgage — or at least I've never heard of someone being denied a mortgage or a practice loan — that started off with a 20-year fixed rate loan refinancing term.

Travis [00:07:52] That's really interesting. So, in other words, every case I've ever heard of somebody getting denied for a really important loan that they were trying to get because of the fact that they had refinanced, it was all because they had chosen the super-short, aggressive repayment schedule for the refinancing loan term instead of one of these longer-term ones.

What, exactly, is student loan refinancing?

Travis [00:08:09] And perhaps I need to even back up a little bit more. I mean, I'm talking about this stuff kind of like somebody that's involved in the space a lot. Let me just back way up and just tell you what refinancing is for the people who are not, you know, Ph.D.s in loan gobbledygook listening to this. So, refinancing is when you take your loan — either at a private or a federal lender — and you move it to a new private lender, presumably at a lower interest rate because that's the main reason you do it. That's really the only good reason to do it.

Travis [00:08:34] There's, you know, maybe another reason would be if you were trying to get a lower payment. You know, you can technically refinance to a higher interest rate. You just would maybe be refinancing to, like, a 20-year term to get a lower fixed monthly payment, perhaps. But generally, it doesn't make sense to do that. The main application of refinancing is to lower your rate and lock that in. Or at least, get a very high probability of interest savings if you do a variable rate. So, that's what refinancing is for student loan purposes.

How student loan refinancing differs from other refinancing

Travis [00:09:00] Now, how is student loan refinancing different from other kinds of refinancing? Other kinds of refinancing, like refinancing your home — You know, refinancing your home is going to come with significant upfront costs. Generally, you have to get the home inspected. There's generally some, maybe, closing fees involved. So the bank kind of gets you with these upfront costs where you have to weigh that against how long you're expecting to keep the loan around. So, if you keep your mortgage loan around a long time, then probably makes sense to do the refinancing because, you know, you're going to have that upfront fee spread out over many years of savings on interest to kind of offset that.

Travis [00:09:37] But with refinancing your student loans, there's good news. There [are] no origination fees. There's no upfront fee to refinance your student loans. That means that there are no transactions costs, which is a huge difference compared to other kinds of refinancing. Now, in fact, with Student Loan Planner®, if you go to StudentLoanPlanner.com slash refi — r-e-f-i — you'll see that for our situation, there's actually reverse transactions costs because we give you cash-back bonuses.

How Student Loan Planner®’s cash-back bonuses work

Travis [00:10:04] And just so you know how we do that: We take less money than everybody else. So, everybody else on the web gets paid, too, for telling you to refinance. You know, I'm going to let you into the dirty, dark little secret here. Everybody in the world makes tons of money when you click on their links to refinance. OK?

Travis [00:10:20] The difference between our site and other sites is I was thinking, “Well, I want to make sure that we reduce that conflict of interest to ever suggest refinancing. So what if we give approximately two-thirds of the payout or half of the payout — or, you know, it depends on the lender. But you know, what if we gave a lot of that payout that we would get normally back to the end user instead in the form of a cash-back bonus?” That's always been my philosophy. If we can negotiate a cash-back bonus, we're going to try to do that.

Travis [00:10:49] We're going to try to get the best deals anywhere on the internet, too, because what's the point of getting a lender on your site if it's not going to be the best deal? So, that's what we work towards. I can't promise we're always giving you the best deal on every lender in the world because that would be very difficult. But we do our best, and we're doing a pretty freaking good job. We've got 95% of the refinancing market available on our site in terms of who actually does refinancing. Because, you know, a lot of people say they do, and they don't really offer good rates. And so we don't put any of those on our site.

Travis [00:11:18] If you think about refinancing in general, refinancing your student loans is a kind of a no-brainer if it makes sense — if the math makes sense. And we'll get more into that in a second. But just know that refinancing your student loans multiple times is not only legal, it is very, very smart to do because of these zero transactions costs for doing it and also the fact that you get cash-back bonuses every time that you do it.

Travis [00:11:42] Let's think more about this in terms of when it's appropriate. So, remember that if you do the Revised Pay As You Earn (REPAYE) program and your interest is — if you're required payment is less than your interest, then the REPAYE program gives you a subsidy on half of all the remaining interest that your payment doesn't cover.

Travis [00:12:01] So, for example, if you graduate from residency and you go get a big attending job, you probably will get a massive subsidy on your interest for the first year without you having to really refinance at all. And in that case, if you aren't maximizing your retirement, contributing money to a brokerage account; you don't already have an emergency fund. You know, you're not already financially stable. Why would you introduce a huge monthly payment when you could get the REPAYE subsidy for six months to a year while you're getting on your feet and getting ready to refi to an aggressive rate? If you're super financially secure, you might even consider bypassing that really long 20-year fixed rate and doing a 10-year straight out of the gate.

The differences between short-term and long-term refinancing

Travis [00:12:37] Now, here's another high-level fixed rule — you know, good rule about refinancing. So, there [are] different terms that you can choose for refinancing. A different term means what schedule of years that the loan provider is going to expect you to pay them back with a fixed monthly payment. So, for example, if you have a different series of terms — here [are] the most common ones. So, you'll generally have a five-, a seven-, a 10-, a 15- and a 20-year term. Those are generally the five different choices that you can choose from when you're doing a refinancing with a private lender.

Travis [00:13:08] Some lenders — like Earnest, for example, on our site — let you choose your payment. Basically, you can do, like, an eight-year or, like, a 12-year or 13-year or whatever. So, it doesn't have to just be those five choices. But most lenders — the vast majority of lenders — have those five different long-term options.

Travis [00:13:24] So, if you go with a five-year term, your payment is going to be way higher. And why would anybody do that? In general, it's because the shorter your loan term, the lower the interest rate that you're going to get on your loan. And the reason for that is because, generally, investors ask for more interest income to justify locking their money up for a longer period of time. Right? So, there's a premium that has to get paid in order for investors to be willing to lock their money up for a long, long time.

Travis [00:13:53] Now, what's really, really weird in the economy right now is there's something called yield curve inversion — which I'm not going to get into because that's complicated. But basically, short-term rates are really high and long-term rates are really, really low. Because of that, it's creating really, really good opportunities in the longer-term rate range, and the opportunities in the shorter-term rate range are not nearly as good as they have been in the past. So, that's making some of these longer-term loan terms the most attractive, perhaps, that they've ever been in history.

How to calculate your payment with various loan terms

Travis [00:14:26] I'll give you an example as to what your monthly payment might be if you're choosing different loan terms. OK? So, for a 20-year term for $200,000 of principal balance — and this is for any loan term, by the way — in general, about two-thirds of 1% of your balance is going to be the 20-year fixed rate payment. For example, two-thirds of 1% is, you know, 0.01 times two-thirds. So, that's about 0.066. So, if you multiply that by $200k, that comes out to about $1,300 a month.

Travis [00:14:58] For a 10-year, you know, that's very straightforward. A 10-year is just 1% of the principal balance, usually, and that's your monthly payment for the 10-year term. And then the five-year term is generally 1.8% of the principal balance. So, 0.018 times $200k is about $3,600 a month.

Travis [00:15:18] So, if you were going to do a 20-, a 10- and a five-year for a $200k loan balance for refinancing, just a ballpark figure would be $1,300 a month for a 20-year; $2,000 a month for a 10-year; and $3,600 a month for a five-year. And to prove to you that this works, I ran these numbers through an actual refi simulator, and the monthly payments were $1,320 for the 20-year; $2,045 a month for the 10-year; and then $3,638 for the five-year. So, really quite close to those general rules of thumb that I gave you.

Travis [00:15:52] So, take whatever loan amount that you have and multiply it by .066 if you want the 20-year term — 0.0066, I should say; 0.01 if you want the 10-year. And then 0.018 if you want the five-year estimate of what your rate and your monthly payment would be.

Travis [00:16:10] The issue with the refinancing ladder is — what you do is you start off with a longer-term refinancing, so you have a low required payment. So, in that example of a $200,000 loan balance, you start off with a $1,300-a-month required payment for the 20-year loan term. And then you refinance after making huge extra payments to a 10-year or any shorter loan term after you've made a bunch of payments.

Travis [00:16:31] And the reason for that is because it keeps the required payment low, so it adds minimal stress on your monthly budget just in case something goes wrong. And then it also gives you the ability to refinance later into a more aggressive term down the road.

Travis [00:16:43] So, that is the key to the refi ladder, is it gives you the confidence to start and get going with a lower rate but make huge extra payments. And remember with student loan refinancing, there [are] no prepayment penalties. So, you can go on there, and you can start off with a 20-year term. But you can pay an extra $5,000 grand a month. In fact, I would encourage you to do something like that if you're doing this — if you're starting off with a 20-year term. And then you refinance it to a shorter term.

Travis [00:17:09] And then what you can do at the final stroke is refinance from a seven- or 10-year fixed rate to a five-year variable rate. We're going to get into that later in the episode as to why you would use that.

How many times do people generally refinance?

Travis [00:17:19] So, we asked readers in a survey how many times they had refinanced. If you had refinanced, how many times have you done it? Almost 90% said only once. That was shocking to me. I would have thought a lot more people would know that they could refinance more than one time, especially in this falling-interest-rate environment where rates have just gone down and down and down.

Travis [00:17:41] Now, in the same survey, we asked people how much of a rate improvement would you need to refinance again. Fifty-one percent of people said they would need a 2% better rate at least to justify refinancing their loans again. That is nuts. That is certifiably, mental-asylum crazy. OK?

Travis [00:18:00] And the reason for that is because if you need a 2% rate improvement — so, let's say you have a $200k loan balance. And you need a 2% rate improvement to refinance again. Then you are comfortable giving away up to $4,000 a year in interest, just to not [have] to think about refinancing again. Right? Even if it's just a 1% lower rate, that $2,000 is something that's going to go towards principal instead of interest if you refinanced again.

Travis [00:18:29] So, how much do we hear about people haggling over their cable bill for $10 a month? Meanwhile, you've got a student loan refinancing sitting at a 5% rate for 10-year fixed rate. And then you could have refinanced that and cut your rate by half a percent or 1% and saved — super easy — $500 or $1,000 or $2,000 with, like, less than an hour of work. So, if your hourly rate is below $1,000 an hour and you already have private loans, you need to check the refinancing market again right now — especially if you refinanced in, you know, any time longer than the past three months.

How to use the refinancing ladder strategy

Travis [00:19:06] Here's kind of how this refi ladder approach works. I want to do this without using super-complicated math because I hope I [didn't] lose some of you already just talking about the rules of thumb to calculate your payments. So, I'm not going to use, like, fancy amortization tables. I'm just going to use straightforward math so you don't get super confused or anything.

Travis [00:19:23] So, let's say that you've got a $300k loan at a 7% interest rate. All right? And let's say this person knows that they need to refinance at least at some point because they want to get to dollar zero with their monthly payment. And so we've got $300k at a 7%. So, that interest cost would be $21,000 under the Standard Plan, if you were going to pay it back to the government. And that monthly payment would be about $3,483 a month if you did that. $3,483 a month — you could do that. Or if you refinanced, you could cut your monthly payment from that level that I mentioned down about $400 a month lower. So, just by refinancing, you could cut your monthly payment $400 a month, and that is no longer going to profit Uncle Sam.

Travis [00:20:09] Now, is anybody getting a 4.25% that I modeled to get to that $3,073-a-month payment for refinancing? The answer is yes. I had somebody get — and I didn't believe it initially because I wanted proof when the person told me — but I had somebody get a 3.8% fixed rate in 10 years the other day. I was blown away. I had no idea that people were giving rates that low. And some of these lenders are resetting their rates multiple times in a month right now because rates have fallen so fast with the trade war and everything. You've got people getting 4% in 10 years fixed, which is just insanely good compared to, you know, every other month that I've been doing this for the past three years. In the same token, you know, the 20-year rates are also super low, so we'll talk about that in a bit.

Travis [00:20:59] So, let's assume that this person with $300k in debt, they want to buy a house. And maybe let's say, assume this is a dentist. So, we'll say they want to buy a dental practice and a house in short succession. How confident do you feel about showing a $3,000-per-month payment to your bankers in terms of getting approved for the best deal on your mortgage and your dental practice? I think it wouldn't pose too many problems, frankly. But if this debt was larger than that, it would definitely cause problems to do a 10-year term. And even with a $3,000-a-month payment, that's probably not the best thing to have going straight into running a private practice for the first time or making a huge mortgage payment for the first time.

Travis [00:21:36] The interest charge under a 10-year refinancing would be about $12,750 if you did a 10-year fixed rate. So, that's a lot less than $21,000. Now, if you did a 20-year fixed, instead of a $12,750 interest charge, the interest charge is about a couple thousand dollars more a year. So, it's about a $15k interest charge if you did a 20-year fixed rate on $300k. So that payment is about $1,980 a month, and it's about — I'm assuming a 5% interest rate.

Travis [00:22:07] So, yes. People are getting under 5% now and 20 years for fixed rates, which is absolutely absurd. Think about locking your money up for 20 years for an unsecured, non-asset-backed debt, and wow, am I just amazed that people are lending at those levels, honestly. It's just crazy. But if they are, you know, you should take advantage of it — if, you know, if it makes sense.

Travis [00:22:29] Now, let's say that for that 20-year, your payment is about $2,000 grand a month. OK? So, $2,000 grand a month. You've cut your interest charge from $21k to $15k, so you've saved a lot of interest by doing that refinancing, even though it's to a smaller monthly payment.

Travis [00:22:44] Now, what if you pay an extra $5k a month on top of your required $2k payment? So, remember the prepayments for student loans are not hit with prepayment penalties, so you don't have to pay any extra fees for paying extra. You're not dissuaded from doing that. So, in one year's time, you would pay down $300k to $232k.

Travis [00:23:03] So, that's really quite a lot of amount to pay down. So, you paid a whole lot down. So, now let's assume you'd go down the ladder. Right? You started off with a 20-year fixed rate. That's the first rung of the ladder. Now you're walking down the ladder after one year of monster extra payments. Now you're doing a 10-year, but you're doing a 10-year with a $230-something-thousand-dollar balance instead of a $300k balance, which means that you're calculated 10-year payment is way, way less.

Travis [00:23:30] That's the key to the refi ladder, is you're keeping your required payment low and manageable while also saving money on your interest while also getting out of debt. OK? So you're basically avoiding taking too big of a risk by jumping too far down the ladder, more so where you could potentially get hurt if you had this bad economic environment happen.

Travis [00:23:49] If you keep your monthly payment manageable and you're always refinancing every one to two years down to a point where you're getting rid of it with a five-year variable rate, eventually — it's the final rung of the ladder — then you're going to get out of your loan payment probably faster than somebody that just does a fixed 10-year rate. And you're probably going to have a lot less stress in terms of that monthly payment, you know, that would be required of you in terms of how it would affect you psychologically. That's just kind of what I've found talking with a lot of people.

Travis [00:24:15] Now, let's say that you continue that $7k-a-month payment, so you're paying an extra amount. Because your payment required of you with a 10-year rate after you did that massive pay down on the first year of the 20-year fixed, now that you switched to the 10-year, your payment is about $2,377 a month. So, you paid it down a lot, and now you're down to about $2,300-something a month for your required payment because you paid it down first before refi-ing to a 10-year with another company.

Travis [00:24:43] So, let's say this person went to our site and got the $500 bonus for doing the 20-year. Now they went to another company, and they got a 10-year rate. And they got an extra bonus for that. I would not tell you to do this just for the bonuses, but this is just something — if you're going to do it anyway, you should do that and get the payment.

Travis [00:25:01] And in fact, you know, you don't actually even have to change lenders. A lot of these lenders will let you do it with them and let you refi with them. So they won't even make you leave. You just have to find a comparable rate elsewhere to prove that somebody was willing to lend that to you. But if you want to move and get the cash-back bonus, you certainly can.

Travis [00:25:18] Now, if you're making these big payments, you're going to cut your loan balance down to about $160,000 after this next second year of big monster payments. So, you started off with $300k. You paid a whole lot extra. Knocked it down to $230,000. Did the 10-year refinancing. Then you did the whole-lot-extra payment, so you've knocked it down to $160,000.

Travis [00:25:42] So now let's assume that you do a five-year variable rate. So your variable rate interest rate maybe is 2.4%. So you went from 5% to 4%. Let's say 4% or 4.25%, something like that, for your 10-year. And now you went down all the way to five-year variable to 2.4%. So now you're at the bottom rung of the ladder, and your payment is about $2,800 a month. So, in two years, you refinanced basically three times. You refinanced first to the 20-year. Then you refinanced to the 10-year a year later. And then you refinanced to a five-year variable a year after that.

Should you go with a variable or fixed rate?

Travis [00:26:18] So, a lot of people ask me, “What do you think of variable versus fixed?” I don't think the variable rate has a whole lot of benefit if you're doing a very long-term refinancing, personally. Because if you have a term that's really, really long, you don't want to be in a situation where you can only afford to make these small payments and then have your rate go way up because the variable rate goes way up.

Travis [00:26:39] And we'll talk about that a little bit. For example, in this $300k scenario, if you had started out with a five-year variable rate, your payment would have been over $5,000 a month. What would have happened if interest rates went up a whole lot? You know? Then the interest savings that you had rejected would basically get wiped away. And then the situation where you thought you were going to save a bunch of money evaporated, and then all you did is trade your government-required payment for a way-higher monthly payment. So, that certainly wouldn't be good.

Travis [00:27:07] So that's why I really like people doing the five-year variable rate once their loan balance is below $200k, and they can easily afford to make those kinds of payments. We did a five-year variable rate, actually. We started with a five-year variable rate because we were lucky to have below $200k in student loans for my wife. And so we started off back in 2015 with a 2.2% five-year variable rate. And then that variable rate rose to, like, 2.7%. And so then we refinanced again to an even lower rate. And we got, like, a 2.4% or something because we wanted to refi after the rate went up.

Travis [00:27:40] Sometimes they raise the rates. It's not super obvious why they're raising the rates. I mean, sometimes it's mostly because short-term interest rates in the economy go up or down. You know, that's what it's generally tied to. So, just so you understand variable rates and how they work, it's basically based off of short-term interest rates in the economy. So if the Fed cuts rates, then that means your variable rate is going to go down. And as the Fed raises rates, it means your variable rate is going to go up.

Travis [00:28:05] And so the problem we've had for the past year or two is short-term interest rates set by the Fed have been really, really high. And so because of that, variable rates have not looked very compelling compared to fixed rates. Now, if we have a recession, if the Fed has to slash short-term interest rates a lot, variable rates could very easily come back into style and start looking really attractive. And they're already slowly starting to do that with this most recent rate cut that the Fed did.

How historic refinancing rates compare to the rates of today

Travis [00:28:30] Now, if you want to kind of go back in history here: I think that this is really fascinating, so I did this study. This unofficial scientific study. So, there's this thing called the Wayback Machine. So a little fun hack here, even if you don't have any loans you're trying to refinance. There's this thing called the Wayback Machine you can go in and google. And you can take almost any major website on the web, and you can put it in there. And then they'll show you what the website looked like back in time at any point in history. So, they do a capture of various major websites on the internet, and they'll show you what that looked like. And it's just really fascinating because you can kind of see the history of various websites and how good or not so good they looked.

Travis [00:29:12] So, what I did is I went to some major refinancing companies, and I put in their refinancing rate range tables into this Wayback Machine to see what their rates were like back in the past. And so this is what I found. For 2015, I found that most of the major refi companies were lending 20-year fixed rates at about a 6%. OK, 5.99%, technically — but about 6%. In 2016, they were doing a 5.62% and 20-year fixed. In 2017, they were doing 5.45% and 20-year fixed. In 2018, they were doing 5.39% and 20-year fixed.

Travis [00:29:51] And today, the ultra, ultra-low rate range for the 20-year fixed rate is 4.8%. Some places, that's with only — with getting a professional society discount. If you wanted to get those professional society discounts, you generally can apply on our website through the Laurel Road link, and sometimes they have professional society discounts.

Travis [00:30:12] Now, if you don't qualify for any kind of discounts like that, then the lowest rates for 20-year fixed as I record this podcast — which probably could be lower by the time this comes out — but they're about 4.99%. So, within a four-year time frame, we went from 6% rates and 20 years to 5% rates — and below 5% rates, really — for 20-year fixed rates.

Travis [00:30:36] Now, if you look at the five-year variable rates, those have gotten worse. Some of the earliest variable rate offers were, like, 1.9% back in the day, and now they're like 2.3%, 2.4%, 2.5% because that short-term interest rate in the economy has risen. The short-term rates are maybe not quite as good. But the long-term interest rates for refinancing are way, way better.

Travis [00:30:58] And so what's interesting is the 20-year fixed rate is the first rung on the refinancing ladder that you step off the roof on. So, that's your first rung. And that first rung has become a lot more stable and a lot more secure because that rate has gone way down. And so you're getting this benefit of a much, much lower interest rate with the security of a way lower required payment — because that's what you get when you do a 20-year term for refinancing.

Travis [00:31:22] So, if you start off with a 20-year rate, then if we have a really bad recession — well, hopefully we don't have a really bad one. Hopefully we just have a mild one. But if we just had a mild recession, then the Fed would slash short-term interest rates, and then the short-term, five-year type loans will become very attractive again.

Travis [00:31:39] So, I could easily see a situation where the five-year variable rates start getting offered below a 2% at some point. So that is why it oftentimes makes sense to make these big, extra payments and knock down your balance and then refinance multiple times from a 20- to a 10- to a five-year rate and just see, you know, how these variable rates work.

How variable rates are calculated

Travis [00:31:57] Just in case you're curious, there's this thing called 30-day LIBOR (London Interbank Offered Rate). This is generally relating to what the Fed charges banks to borrow money at. I think that's actually what banks charge other banks to lend money at. Whatever. It's just — It's complicated. So basically, there's this short-term interest in the economy the Fed sets, and all these other market people set the short-term interest rate around the world. And then all these other banks tie their rates that they charge you to this rate that's set around the world, thanks to what the central banks do. That's how variable rates work.

Travis [00:32:28] In general, you're not going to have that thing run away on you because the Fed really cares about keeping rates low in a recession. And they care about letting the rates go a little bit higher if there's inflation and things like that. So variable rates are not nearly as risky as people think they are. So that's why I don't mind recommending them to people who have a balance that's something that could be paid down very rapidly if they needed to.

Travis [00:32:50] And that's another point is, you know, variable rates can also be good if somebody can easily pay down their balance. But they — Say that there's a recession. The variable rate goes down. So, you can get, like, a 3% variable rate and 10 years or something like that. Maybe you have other stuff you'd rather put your money in at 3%. Right? And then so maybe you could throw a bunch of money at it if you really needed to pay it down fast because rates rose, and variable rates went up. So, that could be a legitimate use of variable rates.

Travis [00:33:16] But right now, I'm recommending fixed rates for anything longer — 10 years and longer — because it's just such a good deal compared to what it's been in the past, you know, time since I started this.

Why don’t more people refinance their student loans?

Travis [00:33:27] So, here's a good question: Why don't more people do this for their loans? Who is not refinancing their loan again when you could cut your rate by 1% or more? So, what I've found is there's a real lack of awareness for people with refinancing. There [are] really not very many cons for refinancing a second or third time, and there's a lot of pros. But people don't really know that. They're not aware of it. And things that people are not aware of, they generally don't do.

Travis [00:33:55] So, I think people tend to think about refinancing, like, their home — in relation to their home. And they know that it's a hassle to refinance your home mortgage a lot of times. You have to call people. You have to do the closing. You have to get the inspector. It's this big process. But literally, you go online on our site, and you've got a rate offer within two or three minutes — a prequalified rate offer. And then it's maybe an extra 15 to 30 minutes to submit all the paperwork and sign the documents and set up the automatic electronic funds draft from your bank account. And that's — It's just really easy.

Travis [00:34:25] And so again, it's just such an easy way to make a huge amount of money per hour [of] time spent. It's a no-brainer to try to refinance multiple times throughout the course of your loan term. And again, you can give your lender a shot to match it. You know, if you go on our site and you find a lower rate than what you have, you can go get that finalized rate. And you can go back to your lender that you're with and just say, “Hey, can you give me this rate at your place just so I don't have to move lenders. You know, if you don't, I'm obviously going to move my loan because I can, you know. And it's going to save me money, so it would be dumb not to. But I appreciate you give me a good rate initially. And will you give me a lower rate?” And most of them will say yes in my experience.

Travis [00:35:06] So, you don't have to refinance. You don't have to pick up that extra cash-back bonus if you just want to keep it where it's at. You can just get the lower rate and the changed monthly payment without having to change anything.

Why putting off your financial health is unwise

Travis [00:35:17] You know, clearly, inertia is a big problem. People don't make changes. How do I know this? Because I'm guilty as charged. How long did I wait to move my savings to a rate where I was getting to almost 2.5% instead of, you know, almost nothing? I waited, like, six months to a year when I could have done it way sooner just because I just — you know, lazy. How long did I take to look for a cheaper-term life policy? I was paying way too much on my term life policy relative to what I wanted to buy, which was more coverage. And it just took me way too long because I was, again, being lazy.

Travis [00:35:49] So, this is an anti-lazy podcast. We are in laziness recovery together — you and me. So, we are going to take positive action for our finances and not let the evil laziness monsters prevent us from doing good work and saving money and paying too much interest to people and lining their balance sheets with profit and lots of extra income. OK? So, we've got to take action on this.

Travis [00:36:14] And don't just listen to this and think, “Oh, maybe I'll put off refinancing later.” You know, this opportunity could potentially get worse. And these rates could go up at some point, in which case, maybe you'll be kicking yourself for not checking for a lower rate, especially if you already had private loans. If you have federal loans, you have to make real careful that it's the right thing to do because you can't reverse refinance.

Travis [00:36:33] Now, who needs to check their rates right now? If you're sitting on anything above a — If you have a 10-year term, if you have anything over a 4%, you need to check your rates right now. If you're doing — If you have a 20-year term, if you have anything more than a 5%, you need to check your rates right now. That's how far rates have fallen.

How lenders profit from borrowers who don’t know to refinance

Travis [00:36:50] Now, one kind of interesting thing is a huge profit center for lenders is all the people who are clueless and don't refinance when it's mathematically the smart thing to do. And I know this because I went to a presentation by a manager of a mortgage securities fund — so people that invest in mortgages. And this guy was super, super smart. He had all these quant (quantitative analyst) people. He had, like, [an] M.B.A. (Master of Business Administration) from one of the top schools. And [a] CFA (Chartered Financial Analyst) genius guy. You know, just knew everything there is to know about mortgages and mortgage prepayments and all [this] different mathematical stuff.

Travis [00:37:25] And he said, “My strategy is actually very simple.” He said, “I like to identify people who are clueless that they could save money by refinancing their mortgage.” So, in other words, he finds people that are still paying 5%, 6%, 7% on their mortgage that have just not realized that they could refinance it and get a lower rate. And that group of people pays their mortgage pretty steadily and just doesn't refinance for years longer than they should. And so he buys mortgages like that, and everybody is expecting these big prepayments to come when somebody is going to pay off the whole mortgage. Like, another bank is going to pay off the mortgage and give that person a lower rate. But that doesn't happen for a lot longer than people were thinking.

Travis [00:38:04] And that makes sense because remember, behavioral finance: We're a bunch of emotional creatures that have other things to do with our time than optimize everything about our finances. That taught me a lot about just human nature and about how big institutions think. So, you're not hurting anybody's feelings by refinancing again. You're not going to get a that-was-so-mean letter in the mail from a company when you refinance away from them because you found a better rate. It's a business decision. It's not a personal decision.

Travis [00:38:33] So, you just have to realize that whenever you're making decisions about where your accounts are going to be, you should never put your account somewhere for emotional reasons. Because these companies think extremely logically and extremely rationally. And that's how they make so much money, is they just make business decisions all the time, you know. And sometimes, it's frustrating, but every big company makes these kinds of decisions. And so you should make those same decisions for your own life.

Travis [00:38:56] So, you know, on Wall Street, people who make illogical financial decisions — like not refinancing your mortgage when it's a no-brainer or not refinancing your student loans again for a second or third time because it's a no-brainer — Wall Street likes to call this group of people “dumb money.” And sometimes, it's, like, used almost pejoratively because they're like, “Oh, I would love to go up against some dumb money.”.

Travis [00:39:15] So, when I was a bond trader, you know, everybody loved dumb money because the idea is, you know, people would buy things — Like, for example, you know, you'd have a bond that's for the New York Metropolitan Museum of Art or something. Regular, you know, investors would pay ridiculous prices for this stuff — like, way more than it's worth because they literally just like that museum. And so they would buy their bonds at auction for just prices that were just ridiculous, just because they just liked the name. And they just liked giving their money to that place and getting the interest from that place rather than another place.

Travis [00:39:47] So realize that if you're not optimizing your refinancing situation, then somebody is licking their chops and thinking of you as dumb money. And you don't want to do that. You don't want to be kind of classified as the dumb money. You want to be the smart money. To do that, every time you can refi to a rate at least half a percent lower— I don't think you should do it for, you know, a tenth of a percent or something. You definitely do have better things to do than that. But if you can find at least a half-a-percent lower rate than what you currently have, it's a no-brainer, especially with our cash bonuses.

Who should and shouldn’t refinance their student loans

Travis [00:40:15] And then the caveat — just to play counterpoint here — is I'm seeing more and more people that should not be refinancing. Because as debt burdens get larger and larger, as professions get more and more saturated, future incomes get more and more capped. So, you've got more of a ceiling on earnings. And you've got debt ratios getting worse and worse because schools continue to raise their prices. And the schools that charge the highest prices for tuition are the ones with the loosest admission standards that let the most people in because they have the incentive to, financially.

Travis [00:40:44] So, as this problem [works] its way through the entire economy, it's becoming less and less of a good idea for a higher and higher percentage of professions to refinance, in my opinion. Especially now that we've really cracked the code on understanding, like, the married filing separate, married filing jointly rules — when we can really optimize that decision in terms of the student loan purposes. Like, which one makes the most sense.

Travis [00:41:07] So, I would say that refinancing is the best decision for people with six figures of debt probably one-third to one-half of the time. But there's a whole lot of people that need to be going for, basically, the loan forgiveness strategy. So, just you know, if you're in the private sector, if you owe less than 1.5 times your income — So, if you have $100k or up of income, you've got less than $150k of debt. If you have $200k of income, you've got less than $300k of debt.

Travis [00:41:32] If you have that debt-to-income ratio, if you have the emergency fund, if you have really stable finances, if you're putting a lot away into retirement, refinancing is the thing that makes a lot of sense. And if those things don't apply, then refinancing could be one of the worst decisions you make financially.

Benefits of using the refinancing ladder with cash-back bonuses

Travis [00:41:46] So, that's just a caveat. You know, I love the idea of people refinancing if they need to get to dollar zero, if that's the smart thing to do. So, if it is the smart thing to do, just remember this refinancing ladder strategy where you're coming off the roof, you're walking down the ladder to the pavement of zero dollars in debt, right? And you're starting off with that really long-term, you know, monthly payment [and] 15- or 20-year fixed rate just to avoid having to big of a payment. And then you pay way, way, way more than what they're asking you to pay because you can. There [are] no prepayment penalties. There [are] no fees or anything. You pay way, way more than you have to pay.

Travis [00:42:19] And then a year later, you refi to a 10-year or something like that. A medium kind of length term. Then you pay way, way, way more than what you have to pay. And then you refinance to maybe a seven-year or even a five-year. And then maybe you have to consider a variable rate if you pay down the loan balance at least by half.

Travis [00:42:35] So, this approach will get you out of debt a lot faster. It will minimize the monthly payment that you have to pay. It will save you a lot of money on interest. It will stress you out less. And it will prevent you from getting denied for a mortgage or practice loan or any other big loan that's really important to you. And it will also prevent you from feeling stressed where you can't have kids. Making your life set up where it's the primary thing instead of the loans where [they're] the primary thing is very important. So, we always try to make someone's loan strategy match what they want for their life and not the other way around.

Travis [00:43:05] So, if you know that you need to check refinancing rates or if you know that this is something that you're interested in, again: StudentLoanPlanner.com slash refi — r-e-f-i. StudentLoanPlanner.com slash refi. Go check your rates again. You have to use a brand-new email address if you've already applied to these places in the past. Otherwise, you're not going to get tagged for the cash-back bonus.

Travis [00:43:23] That's probably one of our, unfortunately, one of our common complaints is people are like, “I didn't get the cash back.” It's like, well, did you already have an application outstanding that you might have clicked on somebody else's link in somebody else's page, and they got the credit instead of us? And if so, there's nothing we can do about it.

Travis [00:43:37] So, just use a brand-new email when you click on that link on our site to apply, and then go through the application. And then, generally, the cash bonuses get dispersed within usually two to three weeks after the loan gets funded. Most of them send it out through PayPal or something like that. So, it makes a lot of sense to cut your rates right now, especially in the long end of the curve with those 10-, 15- and 20-year fixed rates. So, check your rates and see what you can get.

Travis [00:44:01] And, you know, send us an email — Podcast@StudentLoanPlanner.com — if you want to share some of the rate offers you're getting. I want to hear, especially if you're getting less than 4% and 5% for 10 and 20 years. I'd love to hear that because I think a lot of you will.

Travis [00:44:15] Last point I have for today's episode: Remember we have the StudentLoanPlanner.com slash voicemail link. Please visit that link and leave us a question because we're going to do another Q&A show in the future. And I would love to have a bunch of cool questions to answer for free so that you can get a lot of stuff answered that I wouldn't normally answer in some of our other places. So, if you want some free help, check out StudentLoanPlanner.com slash voicemail and ask your question because we would love to feature your question in a podcast episode that's coming up. Thanks for listening today and go save some money.