If you need to take out student loans to pay for school, you might have the option to choose from variable- or fixed-rate student loans. Knowing the difference between the two is crucial, as it affects the overall cost of your student loan debt.
The better type of loan depends on your payoff strategy. For example, fixed rates are better for long term debt payoff. Variable rates are better for short-term payoff strategies that take no more than 2 years, or 5 years max. The difference is fixed rates don’t change, while variable rates do.
Refinancing can give you many options for both loan types and allow you to get the best or lowest rates. In general, variable rates are likely to be lower. They should be at least 1% lower than any fixed rate to make it worth it since you can’t predict future rates that depend on the economy.
Read on to find out more on how a variable vs. fixed rate student loans differ and how to decide which type makes sense for you.
Variable vs. fixed rate student loan
As mentioned, there are two different interest rate types: variable and fixed.
Variable means your rate can change over the course of your repayment term, depending on economic factors and the market. Fixed rates, on the other hand, remain unchanged over the course of your repayment.
If you take out federal student loans, your rates are fixed. All federal student loans have fixed interest rates, so the interest rate remains the same throughout your repayment.
Private student loans offer the option to choose from a variable vs. fixed rate student loan. Variable rates may be lower and seem more enticing, but it’s important to think long term and understand how your rate affects your repayment. Especially if they are subject to change with the market.
How do rates affect student loan repayment?
When it comes to student loan repayment, your interest rates affect the overall cost of the loan. If you have a fixed interest rate, you’ll know how much you’ll pay in interest over the life of the loan, as your interest rate won’t change.
If you have variable rates, your rate could shift. That means there’s some uncertainty with just how much you’ll pay for the total cost of the loan, as well as on a month-to-month basis.
You might score a low variable rate and feel like you’re saving money on interest. But it could spike during a market shift, and you’d end up paying more — or saving no money at all.
Variable vs. fixed student loan: Which is best?
In general, getting a fixed-rate loan is better for student loan borrowers. There’s more certainty, and you know what you’re getting into. If you’re looking for stability and consistency, a fixed-rate option makes more sense for you.
You won’t have a choice if you opt for federal student loans, which should be your first student loan option anyway. Federal student loans also come with a number of borrower protections, such as student loan forgiveness and income-driven repayment for a lower monthly payment.
Weigh your options for variable-rate loans
If you must take out private loans and have the option to get a variable rate, look closely at the difference. A significant rate contrast — let’s say more than 1% to 2% — could potentially be worth going this route if you can pay off the loan quickly.
You never know when variable rates may change, but if you can pay off your loans fast, a variable rate may help you save money on interest.
Variable rates are typically better when the Federal government drops short-term interest rates. This can be advantageous for the borrower and be a good time to choose a variable-rate student loan.
The London Interbank Offered Rate is used as the benchmark for current rates. You should plan to check it to see the average available interest rates before signing onto a variable-rate loan.
Getting the lowest rate
As a student loan borrower, you want to score the lowest interest possible. Interest is what can make paying off debt tough, as it accrues daily.
In order to score the lowest interest rate, there are a number of things you can do.
1. Sign up for autopay: If you sign up for automatic transfers from your bank account to your loan servicer, you can get a 0.25% interest rate reduction. Just make sure you have the funds in your account every month to avoid any overdraft fees or hassles.
2. Refinance your student loans: Here’s the good news — if you don’t like your interest rate after graduating, you may be able to get a better interest rate by refinancing your student loans. If you have strong credit, you could save thousands of dollars by refinancing. If you refinance your federal student loans, however, you’ll give up your borrower protections.
3. Check various lenders: Not all lenders are alike, so to find the best rate, compare multiple lenders to see their offerings. They are likely similar, but one lender may be able to offer you a better rate.
4. Keep your credit in shape: If you’re applying for private student loans, your credit is used to determine your rate. If your credit score isn’t that great, boost it up before refinancing or applying for a new loan. You can help your credit by making on-time bill payments and keeping your debt-to-credit ratio under 30%. Also, minimize the amount of credit you take out.
Following these simple guidelines could help your credit.
Variable vs. fixed rate student loan: Which to choose?
If you’re in the market for a new student loan, you may have the option to choose between a variable and fixed rate. Whether you’re looking into variable vs. fixed student loans, look at the repayment term and make sure you understand how much it will affect the total cost of the loan.
Even if you change your mind later on, you’ll still have options down the road. Remember, you can refinance as many times as you want.
Do your due diligence before making a final decision so you’re setting yourself up for a manageable repayment strategy in the future.