Higher education can open up a world of opportunities but often comes with a hefty price tag. According to Forbes, Americans collectively owe more than $1.6 trillion in student loan debt. Nevertheless, fixed or variable student loans remain the most popular way of funding higher education in the United States.
One of the most important decisions when taking out a student loan is choosing between a fixed or variable interest rate. However, as you navigate student life, knowing what’s best for your financial future can be challenging.
In this article, we’ll help you understand the key differences between these two types of loans and give you tips for choosing the one that’s right for you.
Please note that the content in this article is meant to inform you about the different options for student loans and should not be taken as financial advice.
Fixed interest rates are exactly what they sound like – the interest rate stays the same for the duration of the loan. As a result, you will have a fixed monthly payment that does not fluctuate. Most private and federal lenders offer fixed-rate student loans.
Here’s a representative example of how a fixed-rate student loan works. Let’s say you borrow $20,000 in federal student loans with a fixed rate of 5%. The loan term is set at 10 years, repaid through monthly installments. With a fixed interest rate, your monthly payment will remain the same for the entire 10-year loan term. In this case, the monthly payment amount would be approximately $212.47.
Fixed interest rates come with many benefits. If you opt for a federal student loan or choose a fixed rate with a private lender, these are some of the advantages you may experience:
On the other hand, you might miss out on several opportunities if you go for a fixed instead of a variable-rate student loan. Some of the disadvantages include the following:
All federal student loans have a fixed interest rate. Conversely, private lenders may offer both options. If you plan to pay off your student debts over a long period, you may prefer a fixed-rate loan option. Fixed rates are also a good choice if the rates are currently low and you expect them to go up in the future.
Overall, a fixed-rate student loan can be a good option if your current income is low and you don’t want to risk paying more if the rates go up in the future.
Variable interest rates are tied to market conditions and can fluctuate over time. They are only offered by private lenders. These lenders usually tie the rates to a benchmark rate, such as the prime rate or the Secured Overnight Financing Rate (SOFR) index, plus a fixed margin.
The prime rate is the reference rate that influences consumer interest rates, while the SOFR is tied to overnight repurchase agreements in the U.S. Treasury. When both rates fluctuate due to monetary policy or inflation expectations, it affects the variable rates on student loans.
Here’s an example of a variable-rate student loan. Suppose you borrow $20,000 in private student loans with an interest rate of 5%. The loan term is 10 years, and you have to repay monthly. After three years, the lender raises the interest rate to 6%. This means that the monthly payments in the first three years would be approximately $207.94, while in the remaining seven years, the monthly payments would increase to $232.88.
Choosing a variable interest rate also comes with a list of advantages. Here are the pros of selecting a variable-rate student loan:
However, you might face some risks if you choose to go with variable rates. These are some of the drawbacks:
Variable-interest student loans can be a better option if you plan to pay off your debt early. If you qualify for the lowest rate possible and repay the loan before interest increases, you may save money.
If you’re unsure about what variable rates are, it’s important to remember that they are tied to market fluctuations. As a result, they come with considerable risk. If you have some wiggle room in your budget, you can aim for a variable interest rate if you plan to pay the loan off as soon as possible. Otherwise, variable rates can become a financial burden if they significantly increase, making it difficult to meet monthly minimums. Moreover, variable rates are typically only offered by private lenders that impose stricter eligibility requirements.
What if you started with a variable rate student loan but want to change to a fixed term rate later? Each lender has their own terms and conditions, and you should ask them if it’s possible. If they agree, the only way to change your rate is through loan refinancing.
Here’s how it works. First, you need to search for a new lender that offers a fixed rate and will agree to repay your variable-rate loan on your behalf. In return, you will repay a new student loan to the new lender.
Sometimes, loan refinancing can offer borrowers better rates and terms. However, you will need to meet the new lender’s requirements. As such, the lender that refinances your student loan will conduct financial and credit checks to determine your eligibility.
Before you commit to refinancing your loan, make sure to read the loan agreement carefully. Review the terms and conditions, such as interest rates, repayment dates, and additional fees. Keep in mind that it is not guaranteed that you will receive a better interest rate when you refinance your student loan.
When considering whether to opt for fixed or variable student loans, research and weigh the pros and cons. Here are some tips to help you navigate the decision-making process:
No matter which rate you choose, make sure you understand the terms and conditions of your loan agreement and evaluate how student loans affect credit scores. By reading the loan agreement thoroughly, you will better understand the obligations and responsibilities of the loan. The loan agreement will include information, such as the loan term and monthly due date. It will also include penalty information, such as additional fees. Keep in mind that failing to repay the loan on time can negatively impact your credit score.
For many students looking to pursue higher education, the cost of student loans may be too high to take on. However, there are alternatives to student loans that can help lower the amount you need to borrow and pay back with interest. Here are some common options:
The choice between fixed or variable student loans can be a difficult one. There is no one-size-fits-all answer, as both options have their pros and cons.
However, by understanding the main differences between fixed and variable rates and improving your financial literacy, you can make an informed decision and successfully navigate the student loan process.