Best Student Loan: Variable vs Fixed Interest Rate… There are lots of things to consider when evaluating student loans. The interest rate is an important factor to compare because the interest rate affects the total cost of your loan.
Student loans are one of the ways to help students achieve their dreams of obtaining their degree. When taking out student loan debt, it is vital to be fully informed. That is including the interest rates.
Fixed Rate vs. Variable Rate Student Loans
Understanding interest rates is important because your rate determines how much you’ll pay on credit cards and other loan products, including student loans. So on this article you will get to understand their differences and which is better for student loans.
Variable Interest Rate Loans
There are loans in which the interest rate charged on the outstanding balance varies as market interest rates change. As a result, your payments will vary as well (as long as your payments are blended with principal and interest).
Cost: The initial interest rate on a variable loan is usually lower. This makes it easier to afford during the first year. In addition, if the base rate remains steady, the overall cost of the student loan over its lifetime might be lower.
Caps: Many of the private student loans with variable rates have annual and lifetime caps on interest rates, which protects you during times of wild inflation.
Uncertainty: It’s harder to predict your monthly payment amount, which can confound your budgeting efforts.
Cost: You will pay much more with a variable rate loan if the base rate rises substantially. Caps help, but some loans have outrageously high caps that don’t really protect you that much.
Fixed Interest Rate Loans
These are loans in which the interest rate charged on the loan will remain fixed for that loan’s entire term. That is no matter what market interest rates do. This will result in your payments being the same over the entire term.
Certainty: You know exactly how much interest you’ll pay each month, so it’s easier to budget. Also, you won’t be affected if interest rates climb after you take out your loan.
Cost: In most cases, the interest rate on a fixed loan will be higher in the early years than are the introductory rates on a variable loan. Thus, you may pay out more money in the short term with a fixed-rate loan and possibly in the longterm as well.
Falling Rates: If you take out a fixed-rate loan during a time when interest rates are high, those rates are locked in unless you refinance the loan when interest rates drop. You may have a different rate than someone who took them out even just the year prior to you.
How Do Student Loan Interest Rates Work?
The interest rates that banks, lenders, and other financial institutions charge and pay on deposits is one of the main areas of competition between financial institutions.
If you have excellent credit, you’re likely to get a lower interest rate when you borrow money than someone with a spotty credit history. This is because the bank believes people with good credit are more likely to stick to their repayment plan. If you’re someone a bank or lender considers to be risky, you’re going to pay higher rates in most cases.
Three main factors are considered when determining interest rates on both private and federal student loans. First, there is the Federal Reserve, which sets federal funds rates that affect variable interest rates. There is also a consideration for U.S. Treasury notes and bonds, which primarily affects fixed interest rates.
Federal Student Loans
Interest rates on federal student loans are standardized, so everyone who is eligible for federal student loans pays the same interest rate regardless of credit score. Further, rates are fixed for the life of the loan.
Interest rates are set by federal law and can vary based on the time of disbursement. For example, the interest rate on Direct Subsidized Loans first disbursed between July 1, 2014, and June 30, 2015, was 4.66%, whereas the rate on new student loans for the 2018-2019 school year is 5.05%.
Private Student Loans
Private student loans usually charge higher interest rates than federal loans. A report found the average interest rate on private student loans was 7.99%, while the interest rates on federal student loans ranged from 4.45% to 7% at the time.
Fixed or Variable Student Loan: Which is Best for You?
To start, you should know that all of the best student loan companies offer both variable and fixed rates to borrowers and will give you the option to choose which you want.
Although the right loan depends on your situation, many borrowers prefer fixed-rate loans. This allows you to plan ahead and always know what you’ll be paying. It can be tempting to go with a more competitive variable-rate loan, but it’s always possible the rate will go up and take your monthly payment amount with it.
Fixed-rate loans are an especially good option if you believe interest rates will rise in the future. Because student loan borrowers have different risk tolerances, it’s important to consider which is more important to you: predictability in the overall cost of borrowing and steady loan payments, or the potential for a lower payment with the lowest rate possible — at least in the beginning.
Many private loan lenders provide the choice of a fixed or variable interest rate. Make sure you understand the differences between the two types of loans to determine which loans best fit your needs.
You should also carefully consider your options and determine which rate is more appropriate for your situation.