Making Over Thomas
May 21 -- Thomas is concerned that even after a year of making payments on his student loan, the amount due is higher than when he started. Despite his efforts, he sees himself sinking in a sea of debt.
Thomas took out a student loan with a fixed rate of 8.75 percent. Turns out that was only a "teaser" rate, which converted to a variable rate after one year. Variable rates aren't necessarily worse than fixed rates, especially when interest rates in general are falling. But they do make it difficult to plan because they are subject to change.
A variable rate is usually based on some established and published interest rate, plus a fixed margin. For instance, it could be based on the prime rate (variable) plus 4 percentage points (the margin). At today's prime rate of 7.5 percent, the total interest rate on a loan would be 11.5 percent.
Major lenders periodically change their interest rates, and the prime rate (the rate that they charge their best customers) also goes up or down, producing a change in variable rate loans based on the prime rate.
The Value of an Education
In Thomas' case it appears that his variable rate loan is dramatically higher than the original 8.75 percent. Making the minimum payments on a loan that started at $12,500, Thomas calculates that he will have paid over $42,000 in interest payments by the time he finally pays off the debt, assuming the interest rate doesn't increase. But if it does go up, he could spend as much as $50,000 in interest payments. He's trying to find a way to turn the momentum in his favor and pay the loan off faster.
The most obvious solution is to pay more than the minimum amount due each month. While I'm sure this hasn't escaped his attention, other debts and income issues preclude Thomas from making substantial changes to his monthly payments, making the situation seem pretty hopeless.
As a renter, he's foreclosed from the alternative of taking out a home equity loan to consolidate his debts. (Since the loan is secured by the home, interest rates are generally lower than unsecured debt, and in most cases, interest paid is tax deductible.)
