Unlike federal student loans, private student loans offer you the choice between a fixed or variable interest rate.
You might like this freedom when it comes to student loan interest rates. But then comes the question: Is it better to have a fixed or variable loan?
If you’re leaning toward a variable interest rate student loan, you should consider these risks first.
3 reasons to watch out for variable rate student loans
There were variable interest rates on some federal loans as recently as 2006. But nowadays, only private lenders offer variable rates, which are sometimes referred to as “floating” rates.
Unlike a fixed interest rate, which remains the same during your repayment, a variable interest rate could go up or down — or float — based on market changes.
Review your potential lenders’ policies on rate changes before making a decision. Watch out for these three question marks too.
1. Advertised rates might be misleading
When shopping around with private lenders for a fixed or variable interest rate student loan, you’ll notice this right away. The variable rate ranges are (sometimes significantly) lower than the fixed ranges. That’s because with a variable rate you’re taking on some risk that the rate might increase over the life of your loan.
But it’s important to remember that the rate you’ll qualify for is determined by your credit score and other factors.
Also, no two lenders have the same criteria for awarding interest rates. It’s possible, if unlikely, that you receive a lower fixed rate offer from one lender than the variable rate you receive from another lender.
If you’re on the fence about which rate to select, ask the lenders you’re considering to quote you both fixed and variable rates. Compare these numbers, not the advertised ranges you might or might not qualify for.
2. Repayment options might be more limited
A variable interest rate student loan might be especially beneficial if you have a shorter repayment term. If you pay off your loan over five years instead of 10, there’s less time for your rates to dramatically change.
Many lenders will award lower variable rates for shorter terms. At CommonBond, you could score a variable rate ranging from 3.66% – 9.74%, the lowest rate reflecting a 5-year repayment term.
But not all lenders match their lowest interest rates with longer repayment terms. Citizens Bank, for one, reserves the bottom of its variable rate range for borrowers repaying their loans on a five-year term. The bank also requires the borrower to make in-school payments.
Before signing on for a variable rate, be aware of the repayment plans available to you.
You might find that your credit history (or your cosigner’s) qualifies you for the lowest possible variable rate. But if you’re looking to start repayment after you leave school — or have more time to repay it — ensure the lender meets those needs too.
3. Rates might increase at a bad time
When your variable rate changes, your payments change. That’s because you’re making payments on both your loan’s principal amount and its accruing interest. That’s how student loan interest works.
To ensure you can afford to repay your variable interest student loan, you might prepare yourself for the worst. To do that, ask lenders about their rate cap. That’s the maximum amount that a lender can increase the rate based on market changes. At College Ave, where variable rates ranged between 3.79% and 12.66% in January 2018, the cap was 25.00%.
Depending on the lender, your rate could change monthly, quarterly, or annually. Because Discover bases its variable rates on three-month London Interbank Offered Rate (LIBOR) changes, for example, your payment amount could change every three months.
The bank added its 2.99% margin to the three-month LIBOR rate to come up with its variable rates for customers as of January 2018.
Increasing rates could become problematic, particularly if your lender considers LIBOR monthly. It’s possible that your rate could increase every month for a handful of months or more. But it’s unlikely that month-to-month increases would break the bank.
Consider three decades’ worth student loan variable interest rate history. The greatest one-month LIBOR increase over any 10-year period was 4.29%, according to Macrotrends. Rates rose by that amount between July 2003 and July 2006.
That’s the worst-case scenario of a variable rate. To prepare for it, see if you could afford your monthly payments if your rate increased that drastically.
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There are potential consequences of more modest (and realistic) increases in your interest rate. If you don’t have a big margin for error during repayment, a variable rate on the rise could put you in a tough spot.
Not having enough regular income or savings might make even incremental increases difficult to cover. That’s why many borrowers opt for fixed-rate loans. A monthly payment that never changes is easier to plan for.
Make a wise choice when reviewing student loan interest rates
If you’re considering a variable interest rate student loan from top recommended private lenders, it won’t hurt to do some homework. There’s more than meets the eye when it comes to variable rates. So before you claim the reward of a lower rate now, learn about how your rate could rise later.
If you forecast having no problem repaying your loan if it rises right along with LIBOR, a variable rate might be perfect for you. But if you’re not sure, you might take some time to reconsider the safer bet of a fixed rate.
Review more tips to figure out if variable rate student loans are right for you.
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|* 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.
** Discover's lowest rates shown are for the undergraduate loan and include an interest-only repayment discount and a 0.25% interest rate reduction while enrolled in automatic payments.
1 Important Disclosures for Earnest.
Explanation of Rates “With Autopay” (APD)
In school deferred payment is not available in AL, AZ, CA, FL, MA, MD, MI, ND, NY, PA, and WA).
2 = Sallie Mae Disclaimer: Click here for important information. Terms, conditions and limitations apply.
3 Important Disclosures for College Ave.
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.
(1)All rates shown include the auto-pay discount. The 0.25% auto-pay interest rate reduction applies as long as a valid bank account is designated for required monthly payments. Variable rates may increase after consummation.
(2)This informational repayment example uses typical loan terms for a freshman borrower who selects the Deferred Repayment Option with a 10-year repayment term, has a $10,000 loan that is disbursed in one disbursement and a 8.35% fixed Annual Percentage Rate (“APR”): 120 monthly payments of $179.18 while in the repayment period, for a total amount of payments of $21,501.54. Loans will never have a full principal and interest monthly payment of less than $50. Your actual rates and repayment terms may vary.
(3)As certified by your school and less any other financial aid you might receive. Minimum $1,000.
Information advertised valid as of 7/1/2019. Variable interest rates may increase after consummation.
4 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.
5 Important Disclosures for Discover.
|3.99% – 11.44%1||Undergraduate and Graduate|
|3.98% – 11.35%*,2||Undergraduate and Graduate|
|3.96% – 11.98%3||Undergraduate, Graduate, and Parents|
|3.66% – 9.64%4||Undergraduate and Graduate|
|3.87% – 11.87%**,5||Undergraduate and Graduate|