Understanding the difference and which is right for you could save you thousands of dollars.
When shopping for student loans, deciding how big of a loan you need to pay for tuition, room and board, and books isn’t the only decision you’ll need to make: you’ll also need to look at interest rates and if they are fixed or variable. Why are these last two points such a big deal? Because interest rates will make up a large part of what you end up repaying, especially if you choose a longer repayment period.
It’s pretty easy to understand that high interest rates mean paying more money and should be avoided, if possible. Understanding how variable rates work vs. fixed rates—and which one is best for you—takes a little more explanation, but it’s worth understanding because it affects how much of your paychecks after graduation you get to keep!
A fixed rate means the interest rate on the loan doesn’t change over the life of the loan (how long you spend repaying it). This makes it easier to calculate how much you’ll pay overall in interest and what your monthly payments will be (very helpful when setting up your post-college budget).
If you receive any federal student loans, you will receive a fixed interest rate because Congress sets the interest rates on federal loans each year. This goes for undergraduate and graduate, subsidized and unsubsidized federal student loans. If you receive multiple federal loans, by the time you graduate you could have a different interest rate on each loan, but those rates won’t change. If you consolidate your federal loans after graduation, your interest rate will be the average of your loan rates, but it, too, will remained fixed during repayment.
Some private student loans also offer fixed interest rates.
A variable interest rate increases and decreases based on market conditions. Only private student loans offer this type of interest rate structure.
Choosing a loan with a variable rate is a gamble as interest rates may rise while you are still repaying the loan; however, if when you take out the loan experts are forecasting an imminent drop in interest rates, it could be beneficial to take out a loan with a variable rate to take advantage of lower rates in the near future that you would miss out on if you chose a fixed rate.
Because they have the potential to rise, variable rates usually start out lower than fixed rates on student loans, somewhere between 1.25 percent and 1.75 percent lower.
Choosing a variable rate loan makes the most sense when rates are low and you are able to choose a short repayment period (five years or less). This leaves less time for rates to rise; however, shorter term loans mean higher monthly payments because you’re paying off more of the loan’s principle with each payment.
And One More Thing
One last element to understand and consider when comparing fixed vs. variable rates on loans is when the interest rate starts accruing (adding to the principal amount) and when it can begin fluctuating, in the case of variable rates.
With unsubsidized federal student loans and private loans, interest starts accruing immediately, so you will owe more when you start repaying after graduation, or you could make those interest payments while you’re still in school to ensure you pay the least amount of interest possible on the loan.
With subsidized federal loans, the government pays your interest while you’re in school.
If you take out a private loan with a variable interest rate because the interest rate is low right now, by the time you graduate, it could have already risen. This is a gamble you need to be aware of before signing any student loan paperwork.