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Federal student loans come with fixed interest rates, but if you apply for a private student loan, you may be offered a fixed or a variable rate. In most cases, a fixed-rate student loan is the better choice, but there are some situations where it might make sense to opt for a variable rate instead. Here's what you should know.
Variable- vs. Fixed-Rate Student Loans
When applying for a private student loan, many lenders offer the choice between a fixed interest rate and a variable interest rate. As the names suggest, fixed interest rates remain the same for the life of the loan, while variable rates can fluctuate over time.
As a result, the type of interest rate you choose can have a significant impact on your monthly payment and the total cost of borrowing.
With a fixed-rate loan, for instance, your monthly payment won't change for the life of the loan. However, payments with a variable-rate loan can fluctuate as often as every month based on a benchmark market interest rate, such as the prime rate or the secured overnight financing rate.
However, in most cases, variable interest rates start out lower than fixed rates to make them more attractive to borrowers.
Pros and Cons of Fixed-Rate Student Loans
While fixed interest rates are generally better when it comes to student loans, there are also some potential disadvantages to keep in mind.
- Predictable payments: Your monthly payment will remain fixed for the life of the loan (unless you're on a federal income-driven repayment plan), making it easier to budget every month.
- No chance of a rate increase: When you first take out the loan, you'll know exactly how much interest you'll pay if you stick to the repayment plan—there's no chance that your interest rate and costs will increase over time.
- Attractive when interest rates are low: If market rates are relatively low, you can maximize your savings by locking in a low fixed interest rate instead of a variable rate that's likely to increase.
- Rates start out higher: While variable rates can go up over time, you'll usually start out paying more with a fixed-interest rate.
- No chance of your rate going down: While variable rates can go up, the opposite is also true. A fixed-rate loan, on the other hand, won't become cheaper over time.
- Refinancing isn't guaranteed: If you get a fixed-rate loan when interest rates are high, you can refinance later when rates drop. But unless you have great credit and a solid income, you may not qualify for better terms.
Pros and Cons of Variable-Rate Student Loans
While variable-rate loans are generally less appealing, there are some situations where it might make sense. Here are some advantages and disadvantages to consider.
- Start out lower than fixed rates: If interest rates are high, getting a slightly lower rate right now can provide immediate savings.
- Interest rates can go down: If you have a good reason to believe that interest rates will go down over time, a variable-rate loan allows you to take advantage of those decreases without needing to refinance your loan. Just keep in mind that lenders typically set a limit for how low the rate can go, regardless of the market rate.
- Budgeting can be difficult: With the prospect of fluctuating payments, it can be difficult to budget for student loan payments and other expenses.
- Payments can become unaffordable: Lenders typically set limits on how high your rate can increase with each adjustment and over the life of the loan. But if rates increase significantly, it can still make it difficult to afford your monthly payments.
- Costs are unpredictable: Your lender can give you a range of total interest charges that you may pay over the life of the loan, but there's no way to really know what to expect.
Should I Get a Fixed-Rate or Variable-Rate Student Loan?
In most cases, it makes sense for college students to opt for a fixed interest rate on their student loans. Student loan payments can be burdensome enough, and adding the uncertainty of a variable interest rate to the mix can make repayment even more difficult.
However, if you're a parent taking out loans to help your child or a college graduate planning to refinance your loans, it could make sense to choose that option if:
- You're planning to pay off the loan within a few years and won't be impacted too much by the fluctuating rate.
- Market interest rates are high and are expected to go down.
- Your income is high enough to allow you to take on the additional risk of a variable rate.
Take your time to research and understand both options and how they might impact you. Then, decide based on your risk tolerance, budget and preferences.
Build Credit to Maximize Your Interest Savings
Regardless of which type of interest rate you choose for your student loans, you can maximize your savings by building and maintaining a good credit score. If you haven't had the chance to establish your credit history, Experian Go™ can help you by providing resources on how to develop healthy credit habits. The free service also offers access to your FICO® Score☉ and Experian credit report, so you can track your progress.