When refinancing loans, you can choose between a fixed or variable rate student loan. Both of these work differently. The type of loan you choose will have a considerable impact on how much you pay in interest over the loan term. So which should you pick, fixed rate or variable rate? Well, the short answer is: neither loan type is the best option for all borrowers looking to refinance. The right choice for you depends on several factors.
So how do you decide on a fixed or variable rate loan for refinancing? Understanding how each type works can help you decide which is the best for you.
With a fixed-rate loan, the interest rate is set at the time of refinancing. That rate is locked in for the life of the loan. No matter what the prevailing market rates are, this number will not change at any time.
The interest rate remains the same throughout the life of the loan. The main benefit of fixed rate loans is the fact that the interest rate remains the same throughout the life of the loan. The lenders set the rate at the time of your refinancing application and the number is based on current market rates, your credit score, and other financial credentials. This rate is locked in when you sign the agreement. It won’t change regardless of market conditions. This lowers the risk of a rate hike when markets are stronger.
The monthly payments also remain the same throughout the life of the loan. The main benefit of fixed rate loans is the fact that the interest rate remains the same throughout the life of the loan. The lenders set the rate at the time of your refinancing application and the number is based on current market rates, your credit score, and other financial credentials. This rate is locked in when you sign the agreement. It won’t change regardless of market conditions. This lowers the risk of a rate hike when markets are stronger.
At any given time, fixed-rate loans typically have higher interest rates as compared to variable-rate loans. That means you’ll start off paying a higher rate of interest on your fixed-rate loan. And because the rate is locked in, you’ll continue paying the higher rate until you pay off the loan.
You won’t get the benefit of rate drops. Even if markets are weak and interest rates drop, you’ll continue paying the higher rate that was set when you refinanced. You can’t change the interest rate on your loan unless you refinance again.
With a variable rate loan, the interest rate is based on market conditions. When markets are down, interest rates get pushed down too. When markets are down, interest rates get pushed down, too. When markets are high, interest rates increase accordingly. Because market rates are constantly fluctuating, your interest rate could change several times a year. Your monthly payments will also change along with changes in interest rates.
Lower interest rates at the start of the loan. At any given time, variable rate loans have lower interest rates as compared to fixed-rate loans. This helps you save money right off the bat.
You’ll benefit if market rates drop. Interest rates are based on the index rate. If the index rate drops, so will the interest rate on your variable rate loan. Even if the rate stays the same through the loan term, you’ll still save more than you would with a fixed-rate loan thanks to that lower starting rate!
Interest rates are unpredictable. A major downside with variable rate loans is the unpredictability of interest rates. You could pay less on your loan if the rate drops but you may also pay considerably more if index rates increase.
Monthly payments are unpredictable too. Your monthly payments will change every time the interest rate changes. Setting a long-term budget is difficult under these circumstances. A sizeable rate increase could potentially make your monthly payments unaffordable. A sizable rate increase could potentially make your monthly payments unaffordable.
Ideally, you must make sure to keep room in your budget for rate increases if you choose this option. However, this may not be possible if you’re earning a low income and your budget is already stretched.
A fixed interest rate loan for refinancing may be the better option for you if:
Of course, it’s important to know if and when you should consider refinancing to a fixed or variable rate loan!
You should consider refinancing if:
While you absolutely can refinance federal student loans through a private lender, this is generally not recommended. In most cases, you will already have a favorable interest rate through the U.S. government, and private lenders do not offer the host of repayment, forgiveness, and deferment solutions that the Department of Education offers.
There are several decisions you’ll have to make when refinancing student loans. Choosing between fixed and variable rate loans is just one of the many decisions that will impact the cost of repaying your loan. To maximize the benefits of refinancing, it’s advisable to explore all your options and weigh the pros and cons of each. Compare your offers – don’t go with the first refinancing offer you receive, even if it’s through your bank or credit union. And also consider your current financial circumstances, long-term financial goals, and your risk thresholds to come to an informed conclusion.
When it comes to fixed rate loans vs variable rate loans, there’s no one decision that’s right for all borrowers. Taking the time to consider all your options, however, will help you make a decision that’s right for you.
Want to get more information about your choices when it comes to refinancing and just how much you may have to pay if you do choose a fixed or variable rate loan? Our Student Loan Calculator can help you get to the bottom of this financial decision and help you make a more informed choice!
We hoped you enjoyed this article! Remember, you canand potentially lower your monthly student loan payments and save money.