Federal – Fixed or Variable Rate Student Loan?
All federal student loans come with fixed rates. Congress sets the loan rates each school year based on 10-year Treasury notes plus a fixed increase. The rates are set in the spring for the upcoming school year and are valid for all federal student loans disbursed from July 1 until June 30. Rates vary based on borrower and loan type. Check out the most up-to-date federal student loan interest rates here.
Federal student loan interest rates for the 2018-2019 school year are as follows:
| Loan Type | Borrower | Fixed Interest Rate |
|---|---|---|
| Direct Unsubsidized & Unsubsidized | Undergraduate | 5.05% |
| Direct Unsubsidized | Graduate or Professional | 6.6% |
| Direct PLUS | Parents and Graduate or Professional | 7.6% |
Just because the federal government issues fixed rate student loans doesn’t mean that all your federal student loans will have the same interest rate. Each year, your new federal loans will have a new interest rate. This means that upon graduation, you could have loans with four different fixed interest rates.
Federal Fixed Interest Rate Caps
Congress caps the fixed interest rates based on the loan type. This ensures that rates don’t get too unreasonable. Congress uses the following formula to determine the fixed interest rate cap:
Direct undergraduate loans: 10-year Treasury + 2.05%, No higher than 8.25%
Direct graduate loans: 10-year Treasury + 3.60%, No higher than 9.50%
Direct PLUS loans: 10-year Treasure = 4.60%, No higher than 10.50%
Private – Fixed or Variable Rate Student Loan?
Private lenders offer competitive variable or fixed rate student loans. The majority offer both. Why do they offer both? It makes their loans more marketable to borrowers, offer different options to different people.
The Variable Rate Trap
Variable rates start out lower than fixed interest rates, which could make them appear “too good to be true.” But, you have to keep in mind that variable rates change, and can often end up much higher than their starting point. Lenders intentionally choose a starting variable rate that entices customers but still allows them to earn the same relative margin that they could if the loan was fixed. Your first few months or years might accumulate less interest than a fixed rate loan, but the rate could easily increase in the future.
Before committing to a variable rate loan, you need to talk with the lender directly and read through the loan terms. Speaking with a financial advisor or doing financial market research can also help you weigh the pros and cons of going with a fixed versus variable rate student loan. It’s very hard to predict how risky a variable rate is, but thankfully, you have might have options if the rate starts to skyrocket.
Refinancing Your Private Student Loans
Borrowers with strong credit, a good debt-to-income ratio, and a stable income assume a little less risk when taking on variable rate loan. You’d be a strong candidate for a solid refinancing deal. Refinancing your student loans would give you the chance to change your loan from a variable rate to a fixed interest rate if desired. Since private loan companies don’t typically charge origination fees, refinancing is free. You’ll just need to spend some time doing research and filling out some applications.
By refinancing, you could take a riskier variable rate loan up front and if/when rates start to climb refinance to a fixed rate and lock it in. If you time things right, this can save yourself a lot of money. Again, it’s hard to predict financial markets, but doing research and speaking with a financial consultant helps.
Should I Choose a Variable or Fixed Rate Student Loan?
If you’re set on taking out federal student loans, the choice has been made for you. Federal student loans always have a fixed rate. Better yet, the rate tends to be a lot lower than a private student loan fixed interest rate—unless of course you have excellent credit. Plus, if you qualify for subsidized loans, your interest won’t accumulate while you’re in school. This saves you a lot of money.
If you need to take out a private student loan, the fixed or variable rate student loan comparison comes down to how willing you are to take a risk. In the short term, a variable rate is normally lower and will save you money, but it will likely rise throughout the life of your loan. How high will it rise? It’s hard to know. That’s why variable rates are usually better for short loan terms or loans you’ll pay off quickly. If your loan has a longer term—like 25 years—it’s usually a safer bet to go with a fixed rate.
As you can see, there’s no clear answer or rule of thumb to follow. However, there are a few things you should consider as you decide between fixed or variable rate student loans.
Do you qualify for subsidized federal loans?
If so, they’re really your best bet. They have low fixed interest rates and no interest accumulates while you’re in school. Plus, you get federal borrower protections like repayment plans, death and disability discharge, and potential student loan forgiveness. You won’t find that with any private student loan.
What will your financial situation look like while you’re in school?
If you’re able to make student loan payments while you’re still in college, it makes sense to choose a variable interest rate. Since the rate is lower, more of your monthly payments would go toward the principal.
You would have four years’ worth of payments completed by the time you graduate and no capitalized interest. If your interest rate does rise after graduation, you could always consider switching to a fixed rate through refinancing. Either way, you still saved yourself money by starting with the lower variable rate.
What do your potential earnings look like?
What’s your major? Are you majoring in something like engineering or computer science that will likely lead to a higher paying job? If so, you might be better suited to assume the risk that comes with a variable interest rate. For one, a high income makes it more likely that you could pay off your student loans early. The earlier you pay off the loan, the less interest you’ll pay overall and the less time your variable interest rate has to fluctuate.
You’d also have an easier time refinancing if needed. When you refinance, the lender considers your credit score, your income, and even your job type. If you have a stable job and high income, you have a better chance at securing a competitive fixed interest rate on your refinanced loan.
Do you like predictability?
With fixed interest rate loans, you can predict your future monthly payments right now. Unless you make extra payments on your loans, the monthly payment amount won’t change. You’ll know exactly how much money you need each month to stay on track of payments.
With a variable rate student loan, you don’t have that predictability. You can predict monthly payments based on the current interest rate, but you can’t predict how much you’ll pay if the interest rate fluctuates. Some people don’t mind the unknown. Others prefer having a stable monthly payment. It’s really up to preference.
Final Thoughts
There’s no right or wrong answer when it comes to choosing a variable or fixed rate student loan. You just need to carefully consider your options and figure out which path will save you the most money. If you choose wrong or can’t handle the unpredictability of a variable rate loan, you can always refinance later.
