In many self-storage loans today, there’s one major question for the borrower: “do you want a fixed rate or floating?”. In this Self-Storage University podcast we’re going to explore the good and bad of each option and how you can make your own decision based on your perception of the future.
Episode 126: Navigating The Variable Rate Puzzle Transcript
If you're looking at buying a self-storage facility or refinancing one, one of the major questions you will face as part of your loan process is if you want an interest rate that's fixed or one that's variable. This is Frank Rolfe of the Self-Storage University Podcast. We're going to talk about the concept, how to select what you might think about today when posed with the question of fixed or floating. If the interest rate should be at one spot for the length of the loan or if it should change based on some bellwether, such as the 10-year treasury. Now, this is something you have to do on the front end. This is not a decision that can be made later.
So it's very important when you first start the process of looking at a loan today to start making an educated guess and a methodology to yourself of how to make this choice, this all-important choice. So here are some things to ponder when it comes to variable versus fixed. The first one is that variable rates are traditionally always lower than fixed rates. And that's because a variable rate gives the bank more flexibility. If they make a bad decision, they're not stuck with it for five or 10 years of time. So when it comes to saving money in the form of a lower interest rate, variable typically always wins. But variable rates have greater risk going forward than fixed do. That's the other part of it. It's a risk and reward program. So when you have a variable rate, your rate can go up. But when you have a fixed rate, your rate can't go up. So that's the trade-off between fixed and variable is that variable rates are lower, but they have the risk of moving up. Fixed rates are higher, but they can't go up. So then how do you make the decision between the two? Well, really, it all boils down simply to your bet on the future direction of interest rates.
If you think interest rates are going lower, then variable might work for you. But if you think rates are going higher, then fixed rates would be probably the better option. So then let's investigate what might make rates go lower. Now, Jerome Powell is the head of the Federal Reserve. And as such, the Federal Reserve are the people who set the Fed funds rate, which is basically a very short-term lending option. But that's not the 10-year Treasury. The 10-year Treasury is what mortgages are based on. But if you look at a historical chart, there's always been a relationship between the Fed funds rate and the 10-year Treasury rate. So clearly, if the Fed reduced their rate down, it would have a very material impact on mortgage rates. But Jerome Powell, who was chosen by Trump to be the head of the Fed and then re-upped by Biden, he's taken a very unusual stance on interest rates. When Trump brought him in and affirmed him as the head of the Fed, he was a stalwart of keeping rates very low, nearly zero. However, there was then some kind of change in Powell that occurred back at the start of 2022. And he went from the guy keeping rates at bargain-basement levels to hitting the gas on the car and making those rates go nearly straight up to the highest levels in 40 years virtually overnight.
Who knows what his motivations were? But we found then during the political season, Trump would criticize Powell constantly that he didn't know what he was doing, that he was ruining the economy, that the rates needed to come down. And he had such harsh words for Powell on the run-up to the presidency that Powell today will do anything but lower rates because he hates Trump so much, he doesn't want to do anything that might make Trump happy. Just recently, Trump announced that the rate should be three points lower on mortgages and demanded that Powell do something. Well, Powell is not going to do anything. Powell at this point, I think, would rather see the entire world end than make Trump smile. So he ardently will not do it. However, there's two plans going on. Plan number one is that Trump has announced he's going to go ahead and select the next head of the Fed now and not wait until Powell's term ends in May of next year. And you have to remember that the Fed funds rate is not set by Powell, it's set by a majority vote of a group of 12 individuals inside the Fed.
And by saying, hey, we're auditioning for the new head of the Fed right now, you've already have no fewer than two of those people go rogue and say, yeah, you know what? The rates do need to be lower. I'll vote for lower rates. If he can get the majority or seven of the 12 to vote to lower rates now, it doesn't matter what Powell wants to do. The other issue is that Powell's term does end in May of 2026. So in less than a year, Powell will be thrown out. And I would have to imagine his replacement will be the person who is most vehemently wanting to get the rates back down nearly to zero. So that's the reason to me that you might bet on rates going down because Powell's crazy, crazy term will ultimately come to an end if not now, then no later than May of next year. So that's one big reason why the rates may go lower. And the other big argument why rates may go lower is simply we're about to go into a national recession. Q1 GDP was down, now it revised even worse, 0.5%. And if Q2 is negative as well, which comes out, they announce the GDP for Q2 in only a couple weeks.
And if that's also negative, we will be in what is known as a true recession, which is defined as two successive quarters of negative GDP. And if you look at the historical charts of interest rates and recessions, you'll see that in every recession since 1950, those 10-year Treasury rates, those mortgage rates dropped two to three points during the recession. So those are the two big reasons that I think variable rates might work for people is that it's pretty good bet rates are going to be coming down substantially going forward. Now on the flip side, let's look at the arguments of why rates could potentially go higher. Now, the first one is simply the fact that we have a tremendous amount of debt, a crushing amount, over $36 trillion of federal debt. We've never had this much debt. No country has ever had this much debt. And we have to find people who keep buying the debt, people who will buy our debt and then take interest payments. And they believe in the paper they receive when they buy the debt, they believe the debt will be repaid, that those interest payments will be made.
But there's fewer people out there than before wanting to buy our debt for any number of geopolitical reasons. At a recent auction, in fact, nobody hardly even showed up and the government had to quietly buy the debt ourselves. So some would argue, well, in a normal world, yes, your lower rate argument would make sense. However, I'm not sure we're in a normal world anymore, because if you can't find people to buy the debt, then the rates are definitely going to go up. It's just based on supply and demand. So that could be one reason that we don't see rates go down. And the other is, what if we don't have a recession? I was a Stanford economics major in college, and all economic textbooks point to the fact that historically, we've always had these very natural cycles. And a national recession happens in America roughly every seven to 10 years, and it's never failed to happen since the country was founded. But right now, we haven't had a major recession in America since 2008. That's an incredibly long period of time. You're talking almost two decades on something which has never, ever gotten more than 10 years before. But then others will say, oh, no, now the economy will be doing better. Trump got the big, beautiful bill passed. Things are going to come roaring back.
And if we don't have the recession, that's another reason why then rates would go up, because we really need a recession to push those rates down. Now, the bottom line to all this is that you have to make the decision. You have to be the keeper of your own future and your finances, and you have to decide whether you believe in the future rate decrease or the future rate increase. If you think rates will go up, go with a fixed rate. If you think they'll go down, then perhaps the variable rate. But the person that has to make the decision is only you. And to make a better decision, I urge you to research what interest rates are or will be doing. There's a tremendous amount of information available online concerning interest rates. You can pull up historical charts, any number of different numbers that could go into your consideration. Because at the end of the day, you have to make that very, very important choice. This is Frank Rolfe with the Self-Storage University Podcast. Hope you enjoyed this. Talk to you again soon.