College can be a great experience but to get that experience you have to pay tuition. Most students don’t have the savings to pay for college without student loans. Student loans are a type of financial aid that helps students pay for tuition, textbooks, and living costs while at school. With student loans, specifically private loans, you can choose between fixed and variable interest rates.
Interest rates impact your monthly loan payment and the total cost of borrowing. There are certain benefits to choosing one or the other. Here is what you need to know about student loan interest rates – fixed vs variable.
Why Should You Care About Interest Rates?
Interest is the reason why loans exist. The people that are giving you the money need to see a return for their investment.
But the interest rate can be high for some people. A graduate from Minnesota State University saw only $700 of $6,000 in student loan payments go towards their student loan debt. The rest went to interest.
The interest rate that you choose will determine how quickly and efficiently you pay off your loans. You don’t want to be close to retirement and still paying off your student loans.
With federal loans, interest rates are set by the US Congress and fixed for the life of the loan. Whereas, private loans are offered with fixed and variable rates by private lenders.
Let’s take a look at the two different types of interest rates.
Fixed Interest Rate
A fixed interest rate means that the interest rate that you are paying remains constant over the full term of your loan. Although interest rates may rise or fall over time, you will pay the same interest rate that you originally signed up for when you took out the loan.
A fixed interest rate is beneficial if the interest rate when starting the loan is low. However, if the interest rate drops significantly then you will continue to pay the high rate that you are locked into.
People prefer fixed interest rate because it gives them the security of knowing how much money will be due each month. You don’t have to guess how much you should put aside for your loans. If interest rates are low but are about to increase, it would make more sense for you to lock in your loan at that lower fixed rate.
Advantages and Disadvantages of a Fixed Interest Rate
There are significant advantages and disadvantages of choosing a fixed interest rate over a variable interest rate.
- Interest rate won’t change.
- You always know how much money you owe each month.
- Market rate might be low at the time of starting the loan, which means you will have a low rate throughout the life of the loan.
- Better credit score means you will get a lower rate.
- Fixed interest rate will always be higher than variable interest rates at the start of the loan.
- Takes a longer time to pay off loan.
- Low credit score means you will have a higher rate.
Variable Interest Rate
A variable interest rate is an interest rate that changes from month-to-month based on an underlying interest rate index. The margin that is set will not change, but the index rate will alter over time.
Variable interest rates will be low in the beginning but will increase and change as LIBOR increases. LIBOR stands for London Interbank Offered Rate, and it’s the standard financial index for the U.S. market.
Since the variable interest rate starts off low and increases over time, it should be used if you are confident that you can pay off your loans in a short period of time. A good example of this would be if you need lower payments to begin with while in school.
Advantages and Disadvantage of a Variable Interest Rate
Much like fixed interest rates, there are some advantages and disadvantages of choosing a variable interest rate.
- Initial rates when you start loan are low.
- The interest rate may be lower than a fixed variable rate.
- Interest rate will be low if you pay off loans quickly.
- You can borrow more money even if your credit isn’t perfect.
- Interest rates are unpredictable and can increase any given month.
- You have to guess how much money to put away for loans each month.
- You might not have enough money to pay interest.
Should You Choose Fixed or Variable?
It is difficult to choose between the two interest rates because of some complicated variables that are involved. It all depends on your situation.
If the interest rate is low and you prefer stability, then you should choose a fixed interest rate. If interest rates are declining and you feel like you can pay off your loans rather quickly, then choose a variable interest rate.
Keep in mind, that you can always refinance private student loans with variable rates into a fixed-rate loan.