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Unlike fixed rates, which stay the same over the life of the loan, variable rates fluctuate over time. Because they can go up or down, variable rates entail more risk than fixed ones. But they also have the potential to save you hundreds of even thousands of dollars in interest payments.
Whether you’re taking out a loan or refinancing for new terms, you’ll have to choose between a variable and fixed rate student loan. Read on to learn whether variable rate student loans could be right for you.
What are variable rate student loans?
A variable rate means that the interest rate you are charged on the debt’s balance can (and often will) change over time. If your interest rate changes, your monthly payment can fluctuate, as well.
However, your lender can’t just raise rates whenever it feels like it to get more money out of you. Instead, rate increases are driven by prevailing interest rates in the financial market.
Most private lenders will set and raise variable rates in step with the London Interbank Offered Rate (LIBOR). This is the average of the interest rates banks charge each other to borrow and lend money between institutions. They usually charge a market rate plus the LIBOR rate.
Historically, LIBOR rates have remained fairly low since plummeting during the Great Recession in 2008. However, since the Fed raised its rates in Dec. 2015, the LIBOR has risen.
Variable rates tend to start lower than fixed rates
Considering the fact that variable rates can increase, you might be wondering why anyone would choose a variable rate over a fixed one. Well, variable rates tend to start out lower than fixed rate student loans.
So even though you’re assuming a certain level of risk that your rate could go up, you’re also getting a rate that’s lower than the one you’d get on a fixed rate student loan.
How much lower is a variable rate than a fixed rate for student loans? That all depends on the terms of your student loan.
Typically, choosing a variable over a fixed rate student loan would result in an initial interest rate that is 1.25% to 1.75% lower.
When variable rate student loans are a smart option
Because a variable rate student loan starts with a lower interest rate, there can be potential for savings.
You think interest rates will remain low
The variable rate for a loan will be tied to general interest rates. Although these have been historically low, they have been ticking up in the past couple of years. What’s more, many economists are forecasting multiple interest rate increases in 2018.
It’s impossible to truly predict the future of interest rates. But if you look at trends you might decide that the lower interest rate now is worth the risk of it rising later.
If you get an offer for a variable rate that’s a lot lower than your fixed rate offer, you could still save money over the life of the loan.
You’re looking for lower initial payments
Another benefit of a variable rate student loan is that with a lower initial rate, you also have lower monthly payments.
With the typical savings of a 1.25% on a variable rate student loan, monthly payments will be about $10 to $12 less per month for each $10,000[c] of the loan.
There are plenty of recent college graduates who have entry-level pay now. However, they may expect big increases in pay in year to come.
On average, workers see big wage growth in their 20s. Most 30-year-olds are earning 60 percent more than their entry-level pay, according to a PayScale survey.
If this sounds like you, a variable rate student loan can help you get lower monthly payments now. This is great if you need low monthly bills ASAP.
Just make sure you’re staying on track to earn pay increases. This will help offset the risk of monthly student loan payments becoming unaffordable if your variable rate increases.
You’re choosing a short repayment period
A shorter repayment period can also help you minimize the risk of a variable rate increase on your private student loans.
For example, if you have a 10-year repayment period, that exposes you to the risk of rising rates for a long time. But if you are planning to get a two-, three- or even five-year repayment plan, a variable rate student loan starts making much more sense.
That’s because there’s much less time for rates to increase, which makes it more likely that you will keep the savings you get with the initially lower variable rate. Likewise, you can also prepay your student loans and make extra payments to further limit your risk of rising rates.
Of course, a shorter loan term will mean higher monthly payments. So make sure you can realistically afford these monthly costs. After all a shorter, variable rate student loan has a lot of potential for savings on interest.
You’re going back to school and want to refinance private student loans
Unlike federal student loans, repayment on private student loans typically can’t be deferred if you are returning to college.
This means many students who want to finish their undergraduate or graduate degree will have to figure out how to cover monthly payments for private student loans — while juggling a full course load in college.
That’s where refinancing private student loans can be a major cost-cutter for borrowers returning to school. Many borrowers with private student loans could refinance to get a lower interest rate. And, choosing a variable rate student loan can get them the biggest savings.
If they refinance with a variable rate student loan, this can help them get lower monthly payments while they finish school. These cheaper payments can ease up a lot of the pressure on a student’s already-tight budget.
Then later on, if rates do rise, they will hopefully have a degree that will help them earn more to cover those higher costs.
Are variable rate student loans right for you?
So should you choose a fixed rate or variable rate student loan when you get a new or refinanced student loan?
First, you should do the math to see what you’d actually be saving on interest. Use one of our student loan calculators to calculate your monthly payments and compare interest rates on multiple loan offers.
Besides doing the math, ask yourself how comfortable you are with the risk of a rate increase, along with how many years you expect it will take you to pay off your debt.
Variable rate student loans aren’t for everybody, but they can be a big money-saver for some. Depending on your circumstances, variable rate student loans could help you save on interest, lower your monthly payments, and even pay off your education debt ahead of schedule.
Rebecca Safier contributed to the reporting of this article.
Need a student loan?Here are our top student loan lenders of 2019!
|1 Important Disclosures for Ascent.
Before taking out private student loans, you should explore and compare all financial aid alternatives, including grants, scholarships, and federal student loans and consider your future monthly payments and income. Applying with a cosigner may improve your chance of getting approved and could help you qualify for a lower interest rate. Ascent Student Loans may be funded by Richland State Bank (RSB). Ascent Student Loan products are subject to credit qualification, completion of a loan application, verification of application information and certification of loan amount by a participating school. Loan products may not be available in certain jurisdictions, and certain restrictions, limitations; and terms and conditions may apply. Ascent is a federally registered trademark of Turnstile Capital Management (TCM) and may be used by RSB under limited license. Richland State Bank is a federally registered service mark of Richland State Bank.
* Application times vary depending on the applicants ability to supply the necessary information for submission.
2 Important Disclosures for CollegeAve.
College Ave Student Loans products are made available through either Firstrust Bank, member FDIC or M.Y. Safra Bank, FSB, member FDIC. All loans are subject to individual approval and adherence to underwriting guidelines. Program restrictions, other terms, and conditions apply.
Information advertised valid as of 2/1/2019. Variable interest rates may increase after consummation.
3 Important Disclosures for Discover.
* The Sallie Mae partner referenced is not the creditor for these loans and is compensated by Sallie Mae for the referral of Smart Option Student Loan customers.
4 = Sallie Mae Disclaimer: Click here for important information. Terms, conditions and limitations apply.
5 Important Disclosures for SunTrust.
Before applying for a private student loan, SunTrust recommends comparing all financial aid alternatives including grants, scholarships, and both federal and private student loans. To view and compare the available features of SunTrust private student loans, visit https://www.suntrust.com/loans/student-loans/private.
Certain restrictions and limitations may apply. SunTrust Bank reserves the right to change or discontinue this loan program without notice. Availability of all loan programs is subject to approval under the SunTrust credit policy and other criteria and may not be available in certain jurisdictions.
SunTrust Bank, Member FDIC. ©2019 SunTrust Banks, Inc. SUNTRUST, the SunTrust logo and Custom Choice Loan are trademarks of SunTrust Banks, Inc. All rights reserved.
6 Important Disclosures for LendKey.
Additional terms and conditions apply. For more details see LendKey
7 Important Disclosures for CommonBond.
A government loan is made according to rules set by the U.S. Department of Education. Government loans have fixed interest rates, meaning that the interest rate on a government loan will never go up or down.
Government loans also permit borrowers in financial trouble to use certain options, such as income-based repayment, which may help some borrowers. Depending on the type of loan that you have, the government may discharge your loan if you die or become permanently disabled.
Depending on what type of government loan that you have, you may be eligible for loan forgiveness in exchange for performing certain types of public service. If you are an active-duty service member and you obtained your government loan before you were called to active duty, you are entitled to interest rate and repayment benefits for your loan.
A private student loan is not a government loan and is not regulated by the Department of Education. A private student loan is instead regulated like other consumer loans under both state and federal law and by the terms of the promissory note with your lender.
If your private student loan has a fixed interest rate, then that rate will never go up or down. If your private student loan has a variable interest rate, then that rate will vary depending on an index rate disclosed in your application. If the interest rate on the new private student loan is less than the interest rate on your government loans, your payments will be less if you refinance.
If you don’t pay a private student loan as agreed, the lender can refer your loan to a collection agency or sue you for the unpaid amount.
Remember also that like government loans, most private loans cannot be discharged if you file bankruptcy unless you can demonstrate that repayment of the loan would cause you an undue hardship. In most bankruptcy courts, proving undue hardship is very difficult for most borrowers.
8 Important Disclosures for Citizens Bank.
Citizens Bank Disclosures
|4.23% – 13.23%1||Undergraduate and Graduate|
|4.20% – 11.44%2||Undergraduate, Graduate, and Parents|
|4.84% – 13.49%3||Undergraduate and Graduate|
|4.50% – 10.11%*,4||Undergraduate and Graduate|
|4.25% – 13.25%5||Undergraduate and Graduate|
|5.85% – 6.99%6||Undergraduate and Graduate|
|3.95% – 9.81%7||Undergraduate, Graduate, and Parents|
|4.45% – 12.42%8||Undergraduate, Graduate, and Parents|