Fixed vs. Variable Rate: How to Make the Right Choice for Your Student Loans

Fixed- or variable-rate student loans

When it comes to student loans and student loan refinancing, interest rates are a huge factor. Your interest rates can affect how much money you will end up paying back over time; high rates can make it difficult to keep pace in repayment.

But it’s important to know there are two types of interest rates: fixed rates and variable rates. Maybe you didn’t get to choose between fixed or variable rates when signing on for student loans, but if you’re applying for student loan refinancing now the choice is yours.

So how do you know which is best? We’re here to break it down for you.

Student loans with fixed rates

A loan with a fixed interest rate means you’re locked into that rate for the life of your loan. Having fixed rate loans can help you predict how much you’ll pay in interest and keep your interest payments at manageable levels.

Fixed rates tend to be higher than introductory variable rates — but they’ll never change, so you know what you’re in for.

Student loans with variable rates

Variable student loan rates are just that — variable. They can change at any time. These rates tend to be related to the current Fed and LIBOR rates, which serve as benchmarks for many types of interest rates on loans, from mortgages to credit cards — and yes, student loans.

Interest rates have been at historic lows in recent years, allowing borrowers to enjoy relatively cheap debt (the lowest rates are reserved for those with excellent credit scores). For example, student loan refinancing candidates with good credit could potentially score a variable rate below 3.00%.

However, interest rates can rise. When this happens, a low-interest loan could jump to a higher rate and affect your monthly payments.

LIBOR, also known as London Interbank Offered Rates, also fell in the wake of the Great Recession in 2008. They only began to rise by the end of 2015. Most recently, the one-month LIBOR was at 0.47% in mid-July 2016 and more than doubled to 1.23% a year later, according to historical data from Macrotrends.

Committing to a variable rate means committing to the market’s ebbs and flows.

Fixed vs. variable: Which is right for you?

If you have federal student loans, chances are you have fixed interest rates — which can be a blessing or a curse. My undergraduate loans are at the low rate of 2.30%, but my Graduate PLUS Loans are 6.80% and 7.90%. That’s a big difference.

Although I’ve benefited from the low interest rate on my undergraduate loans, I’ve felt insanely frustrated with how high my grad school loan interest rates are.

This is why student loan refinancing is an attractive option for so many borrowers. Through refinancing, you have the potential to earn a lower interest rate, effectively saving you thousands of dollars.

If you have private student loans, you might have variable interest rates that can fluctuate at any time. But as long as rates are low, you can save thousands of dollars in interest charges.

3 questions to ask about your options

There are a few things to consider before deciding if a fixed or variable rate is best for your student loans. First, ask yourself these questions:

  1. How long will it take you to pay off your loans?
  2. What type of interest rate feels most comfortable to you?
  3. Does the variable loan have a rate cap?

If you want to see the whole picture of your loan situation, these questions are important to answer. A variable interest rate might be a good option if you can pay off your loans in a few years or less, before rates climb too high.

Secondly, consider the non-mathematical aspect of the equation. Choosing the rate type that you’re most comfortable with might make repayment easier in the future. If the greater uncertainty of variable rates is going to add to your stress level, for example, put one point in the column of fixed rates.

Also, consider what type of interest rates you currently have. Perhaps you have private student loans with variable rates and are looking to gain the stability of a fixed rate.

How much your choice could save you

Lastly, you should look at the overall savings. How much will you save by refinancing in general? How much will you save in interest by choosing a variable rate over a fixed rate?

Here’s an example showing your total interest and total payment for three scenarios:

Fixed Rate Variable Rate (No Change) Variable Rate (Rising Rate)
Loan Amount $35,000 $35,000 $35,000
Interest Rate 6.30% 5.09% 5.75%
Repayment Term 10 years 10 years 10 years
Monthly Payment $394 $373 $384 (average)
Total Interest $12,264 $9,733 $11,103
Total Payment $47,264 $44,733 $46,103

This example took average rates from Laurel Road and used our monthly payment calculator to do the hard part. As you can see from the results, variable rates can save you money. This is especially true if you have a shorter repayment term — even if rates increase.

On the flip side, rising rates can hinder your ability to budget month to month. The initial monthly payment ($373) and the increased monthly payment ($384) for the variable rate aren’t all that different. But when you sign up for a variable rate loan, you are taking the chance that your recurring payment will rise, putting a potential strain on your budget.

Before you choose which one is right for you, look closely at your repayment term and consider your level of risk tolerance. If your repayment period will be 20 years and you like stability, a fixed rate might be a better option for you. If, on the other hand, you believe the savings of a lower, fluctuating rate outweigh the risk that it could skyrocket, go with the variable rate.

Andrew Pentis contributed to the reporting for this article.

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