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Difference between Variable and Fixed Rate Student Loans
In the United States, in particular, student loans have surpassed savings and individual scholarships as the principal means by which college students pay for their education. And for individuals in their early to mid−30s, paying down college debt has become the new normal. No one would argue that taking out a student loan is easy, but for some who otherwise wouldn't be able to afford higher education, it may be a literal lifesaver. In addition, many people have turned to student loans due to the dramatic increase in the expense of higher education in recent years.
You shouldn't let the fact that you can't afford to send your kids to college right now stand in the way of them enjoying the life and the career they want. Borrowers applying for student loans may be offered a variable or fixed interest rate option. Low−interest rates are generally more desirable, but it's crucial to consider whether they'll be flexible in the future.
What is Variable Rates?
Rates of interest on private student loans have always been variable. Your interest rate will likely be within the range determined by your credit history and the rates offered by the bank or other lender to whom you are applying. Therefore, interest rates that rise and fall in tandem with an index rate, such as the prime rate or the LIBOR, are known as variable interest rates. The cost of borrowing the money the bank must offer you to complete their duty is directly related to this index, thus it is an extremely important factor.
Financial institutions act as go−betweens, borrowing funds to disperse them, with the cost of such borrowing fluctuating nightly to reflect market conditions. Due to the variable nature of an index−linked interest rate, it might vary from loan to loan. So, what do you make of this data? Your regular payment amount may go up or down at different times of the year, depending on the index rate.
Many times, variable rates start much cheaper than fixed ones, but there is always the possibility that they will rise in the months and years to come. In general, your monthly payment amount will be less when interest rates are low and more when they are high. Any changes in the 1−month LIBOR will be reflected proportionally in your new interest rate for student loans.
What is Fixed Rates?
A fixed−rate student loan has an interest rate that does not fluctuate during the loan's repayment term. Meaning, as long as you keep up with your payments, you'll always know exactly how much it will cost you to repay your student loan. According to its name, a fixed rate does not change over time. Your loan's interest rate will remain the same from the day it was set until the day it is paid in full.
If you were offered a fixed interest rate of 7.5 percent when you took out the loan, your monthly payment would remain the same at 7.5 percent regardless of changes in the margin or index rate. As a result, if the index rate drops, you won't benefit because your payment remains the same (7.5%), but the interest you pay will be lower. You will not be responsible for any additional payments notwithstanding any increases in the index rate.
Differences: Variable and Fixed Rate Student Loans
The following table highlights how Variable Rate Student Loans are different from Fixed Rate Student Loans −
| Characteristics | Variable Student Loans | Fixed Rate Student Loans |
|---|---|---|
| Interest Rate | An index rate may be used to determine future adjustments to the interest rate. | At no point will the interest rate fluctuate throughout the life of this loan. |
| Monthly Payment | The monthly payment may rise or fall depending on the index rate. | Monthly payments are set and will never go up or down. |
| Costs | Total payback costs are hard to estimate because of the volatility of interest rates. | You are fully informed of all fees and interest related to paying off your loan. |
Conclusion
As a general rule, the interest rate on a fixed−rate student loan will be greater at the beginning of the loan term than the interest rate on a variable−rate student loan with the same repayment term. With a fixed−rate loan, the interest you pay is based mostly on your credit score and the bank's offered rate range.
A fixed−rate guarantees that the interest rate will not change during repayment. However, if your interest rate is variable, it might go up or down based on the performance of an underlying index (LIBOR). The decision of whether to apply for a student loan with a fixed rate or a variable rate is, therefore, ultimately yours to make. Ultimately, you should pick the one that best meets your requirements after giving serious thought to all of them.
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