Variable vs Fixed Rate Student Loans

Understanding the basic concept of variable vs. fixed rate student loans if fairly simple.  A variable interest rate will change periodically over the term of the loan whereas a fixed rate will not.  The questions many borrowers face is, “which is better?”  Answering that question is more difficult than you might think–at first.  Let’s break down both, so you can make an informed decision about which type to choose for your student loans.

Federal Student Loans: Fixed Rate

To get started, let’s review five key things to understand about federal student loans.

1. All federal student loans have fixed interest rates.
2. The interest rate is set (fixed) prior to July 1st of each academic year and applies to loans made between July 1st and June 30th.
3. If you attend college for four years, for example, you may borrow four times during each of those academic periods.  Your rate on each of those four loans will vary, but will not change over the repayment term.
4. If you attend college for four years and you borrow during each academic period, you could wind up with four loans with different fixed rates. But for each of those loans, their interest rates won’t change over the course of repayment.
5. When you enter repayment, you can decide whether or not consolidating those loans in to a single loan with a single fixed rate makes sense.  Your fixed rate on a federal consolidation loan is the weighted average of the rate on the loans to be combined.  Don’t be scared off by the term “weighted average.”  It just means that the rate on your higher balance loans will count more toward determining the average.

To learn more about federal student loans, and the current fixed rates, see: Federal Student Loans.

Private Student Loans: Variable or Fixed Rate

Now that we have federal loans out of the way, let’s review the five things to know about variable and fixed rate private student loans.

1. Most private student loan lenders today are offering both variable and fixed rate loans.  The LoanFinder (our tool that helps you compare student loans) only includes variable interest rate programs.  We do this because it’s a bit less confusing for borrowers when they are first evaluating their options.
2. A private student loan with a fixed rate will always have a higher interest rate than a variable rate loan from the same lender.  Since student loans are repaid over a relatively long period of time, lenders set rates such that if they do increase in the future, they aren’t losing out on the margin they could earn had the loan been variable.
3. There’s no way to know if interest rates for a variable rate loan will increase. With some research about historical trends and an understanding of the financial markets or, better yet with the help of a financial expert, you can weigh the relative odds that a variable rate loan will increase. But remember: no one can predict the future.
4. When looking at how rates have changed in the past to guess how they might behave in the future, its important to consider your repayment term of a private student loan, it may be 5, 10 or even 15 years in length. How interest rates fluctuate over 5-15 years may be very different.
5. To repeat ourselves: no one can predict the future. A good rule of thumb to remember is that when interest rates have been historically low, they have nowhere to go but up.

Deciding between a fixed rate and variable rate student loan will depend on your particular situation and comfort with risk. To simplify what choosing between the two means: When you choose a variable rate, you are betting that interests rates won’t rise substantially during the repayment term.  If you choose a fixed rate, you are betting that rates will increase.

How To Choose

The bad news is that we can’t choose for you. When it comes to federal student loans, you have no choice; your rate will be fixed. For private student loans, it really comes down to a matter of personal preference and your willingness to accept risk. A variable rate may be lower in the short term, but increase over your repayment period. It could exceed the fixed rate option you were presented when you borrowed the loan at any time–now or along the course of repayment. A fixed rate loan eliminates the guess work, but could cost you a lot more in interest than a variable rate loan whose rate does not increase substantially over the course of repayment. The best advise we can offer is to compare your options and make a choice that feels right for your particular situation. If you need more help deciding, we always encourage borrowers to seek the help of a financial planner or other qualified professional.