When you refinance your student loans the type of interest and rate you choose is extremely important. This can determine how much you will be paying over the life of your loan and how much you will be saving versus your current lender. If you initially got a student loan through the federal government, your rate will always be fixed. When you get a loan through a private lender rates can be fixed, variable, or even hybrid.
In today’s low-interest rate environment, fixed rates can still be very competitive. There is no “right” answer in this decision and choosing the type of rate is a decision you need to make based on your risk tolerance.
What is the difference between fixed and Variable?
Fixed rate: stays the same throughout the loan.
- Less risky: stays the same throughout the life of the loan and today they are generally higher than variable rates.
They are NOT affected by financial market interest rate changes
- You will be charged the same rate throughout the life of your loan (and will know exactly what you will be paying each month and in total)
Variable rate: can change depending on the market.
- More risky: changes throughout the life of the loan (can go up or down) and today they are generally lower than variable rates (usually by about 1.25%-1.75%, but dependent on lender). Variable rates are normally capped, but the cap can be as high as 15%-18%.
- They ARE affected by financial market interest rate changes (with the London Interbank Offered Rate/LIBOR or the rate banks charge each other to borrow and lend money)
- You may be charged a different rate throughout the life of the loan (you will NOT know exactly what you will be paying each month and in total)
- Moderate to more risky: a mix of fixed and variable rates – for example, a loan can be fixed for five years and variable for five years. This type of interest rate is less common, and we would categorize it closer to a variable rate since you have that exposure.
When Does it Make Sense to get a Fixed rate?
- You can sleep well knowing you will have the same rate locked in over the life of the loan. With a fixed rate you can be certain that you will have the same rate for the whole life of your loan. This can be huge when your loan is for ten or twenty years.
- You want predictable monthly payments. Since your income may change throughout the next ten to twenty years, you might want to have predictable monthly payments to plan accordingly. A fixed rate ensures that you will know exactly how much to pay each month.
When Does it Make Sense to Get a Variable rate?
- You believe interest rates will stay the same or go lower. Even though rates have historically been low, they have been going up over the past couple of years. Also, it’s impossible to predict what will happen to rates.
-Expect to pay off loans before major interest rate increases. If you choose a shorter repayment period (e.g., three years vs. ten years), you have a shorter time frame to be exposed to interest rate increases. You do need to keep in mind that a shorter term loan means higher monthly payments.
- You want lower initial monthly payments. With a lower initial rate, you will have lower monthly payments in the beginning which may help you if your income is low. You should just make sure that if monthly payments go up, you plan for your income to increase as well.
- You want to go back to school. For some loans, you need to continue to pay your monthly payments if you go back to school. By changing to a variable rate, you might be able to make less monthly payments while you aren’t earning income, if rates stay low while you are in school. You will need to make sure that if monthly payments go up when you graduate, that you have the higher income increase as well.
So what should you do next?
The best steps are to do the math to see how much interest you will actually be saving and ask yourself how comfortable you are if rates do increase (potentially up to the cap of the variable rate).
Signup here to let Snowball help you do the calculations to find the right type of interest for you.