Fixed or variable student loan: which is better?
Fixed interest rates on student loans are generally a better option than variable rates. This is because fixed rates always remain the same, while variable rates can change monthly or quarterly depending on economic conditions.
If you don’t know which rate to choose, go for a fixed rate; this is the safest option. If you’re comfortable taking a risk and potentially saving on interest – and you’ll be able to pay off your student loan quickly – consider a variable rate.
Fixed or variable student loan?
All federal student loans have fixed interest rates. It is generally best to maximize federal student loans before turning to private student loans, as borrowers with federal loans are eligible for income-oriented repayment plans and loan forgiveness programs – borrowers with private loans will not.
If you are going for a private student loan, or if you are refinancing your existing student loans through a private lender, you can usually choose a fixed or variable rate. Here is how to decide between them:
Fixed student loan rates are the safest bet
Fixed rates are locked in for the duration of the loan. The only way to change a fixed interest rate is to student loan refinancing.
There is no way your rate will go up.
Predictable monthly payments; the amount owed will not change.
Rates generally start higher than variable rates.
You could miss out on the interest savings if variable rates drop.
Interest rates are going up.
You don’t expect to pay off your loans anytime soon.
Variable student loan rates are a gamble
Variable rates are subject to change throughout the life of the loan. Student lenders typically set variable rates based on an economic indicator known as the London Interbank Offered Rate, or Libor. Lenders determine variable rates by adding the Libor rate to a base rate. If the Libor goes up, your rate goes up exactly that much.
Before getting a variable rate student loan, ask lenders how often the rate is likely to change. Some adjust variable rates monthly, while others adjust every three months. Also find out about the overall rate cap. Variable rates are often capped, but the caps can be as high as 25%.
Rates generally start lower than fixed rates.
You could save on interest if variable rates don’t go up too much.
The recent trend has been for rate increases for variable loans.
Unpredictable monthly payments; the amount owed could change.
Your total number of monthly payments may change as the rate changes.
Consider a variable rate if
You plan to pay off your loans before periodic rate increases erode your savings. Here is what Movement of the Libor index looked like in the past.
Interest rates are going down. For example, a borrower who took out a Libor loan at its peak in 2007 would have seen the rate drop by more than five percentage points two years later.
What rate is the best for refinancing a student loan?
Refinancing Can Help pay off student loans faster by lowering your interest rate. If you plan to aggressively pay off your refinanced loan, a variable rate can maximize your potential savings.
But do the math first. The lowest fixed and variable rates for refinance lenders are usually not that far off. This means that you may not be paying much more with a fixed rate, and you will be protected if your repayment plans change.
If you go for a variable rate and the rates start to rise, there is little harm in trying to refinance again.