Student loans come in many varieties. There are federal Direct Loans and PLUS Loans. There are private loans that come with options like a variable rate or fixed, short and long repayment terms. Borrowers often take out multiple student loans at once.
This article will explain the difference between a fixed-rate loan and a variable-rate loan and which one might be a better choice for your student debt.
Fixed-rate loans are loans with the same interest rate and monthly payment amount for the entire life of the loan.
Although you can always pay more than your minimum monthly payment toward your loan, your minimum payment amount will never change.
For example, if you have a fixed-rate loan with 7% interest, you will always pay 7% interest, and your monthly payment will be evenly divided across the loan term.
Variable-rate loans are loans that have changing interest rates and potentially changing monthly payment amounts.
The terms of your loan contract will specify how and why your lender can change the interest rate, but typically it changes when the Federal Reserve interest rate changes.
Because you, as the borrower, have more risk with a variable-rate loan, your initial interest rate will typically be lower than a fixed interest rate would be. However, if interest rates rise, you will be on the hook for higher payments. On the flip side, if interest rates fall, your monthly payments are likely to go down.
For example, if you have a variable-rate loan with 7% interest and the federal funds rate increases by 0.25 percentage points, you may have a loan with 7.25% interest. If the federal funds rate decreases by 0.25 percentage points, you may now have a loan with 6.75% interest.
How to Decide between Fixed-Rate and Variable-Rate Loans
The Department of Education doesn’t offer an interest rate option for federal student loans, so if you take out federal loans, the decision has been made for you. You will receive fixed-rate loans.
If you are looking at private loan options, however, you do have a choice. If you prefer security and stability, a fixed-rate loan will give you consistent and predictable payments for the life of your loan. The downside is that you will be stuck with the same interest rate on your loan, even if market interest rates go down.
With a variable-rate loan, you may get a better interest rate, but you will take on more risk. If market interest rates go up, you could end up with higher payments or a longer repayment period.
The decision to go with a fixed-rate or variable-rate student loan will depend on your preference and your plan for the future. Unfortunately, there are no easy answers.