Refinance Myth: Variable Rates are Too Risky to be Worth It

by Timothy Lickteig on May 20 2021

Have you been advised against choosing variable rates because they’re too risky to be worth it? This is not necessarily true. Sure, there is a certain amount of risk associated with variable rates but that’s true of any type of financial undertaking. Besides, you’ll find that the benefits may outweigh the risks under certain circumstances.

How Does Variable Rate Work?                                                                                       

When applying for a student loan, you can choose between a fixed interest rate and variable interest rate.

With a fixed interest rate, you pay the same rate of interest for the entire loan term. The interest rate is set at the time of taking the loan and doesn’t change at any time, regardless of market conditions.

With a variable interest rate, the rate is not set for the duration of the loan. Instead, you start off paying the prevailing interest rate at the time of taking of loan. This rate changes continuously with market fluctuations. When markets are strong, the rate spikes. When markets are weak, the rate dips. This rate fluctuation could happen randomly, every month or every few months.

Pros & Cons of Variable Rates

The biggest benefit of variable rates is you could benefit from falling market rates. Even a small dip in the rates could save you a substantial amount over a period of time. This is an advantage over fixed rates where you keep paying the same high rate even if markets rates fall.

The disadvantage of variable rates is that the markets could go up, increasing the interest rate on your loan. This would make your loan so much more expensive. The other downside is that it’s difficult to set a long-term budget as your monthly payment could change any time. Compare this with fixed rates where you know exactly how much you have to pay every month till you’ve paid off your debt completely.

Choosing A Variable Rate May Be Worth The Risk Under These Circumstances

Not everyone has the stomach for taking risks. Some people may prefer to be conservative in their approach even if it means smaller savings in the end. No matter which side of the risk spectrum you fall under, it’s definitely worth choosing a variable rate under these two circumstances.

#1- You plan on paying off the loan within a shorter time period. When you choose a shorter repayment period, you get the benefit of the lower interest rates right at the outset. If the market conditions get stronger and rates increase later on, they are less likely to affect you as you will have paid off your loan. Choosing variable rates in a falling market can save you thousands of dollars in interest.

#2- You are looking for a loan with lower initial payments. Initial variable rates tend to be lower than fixed rates. This means your monthly payments will be lower with a variable rate loan. This can be a huge relief when you’re just starting out and on a tight budget. As your income increases and depending on the market conditions, you can then either leave it as is or refinance with a fixed rate.

Are Variable Rates are Too Risky to be Worth It?

The verdict: Variable rates are risky but they’re not necessarily too risky to be worth it. The key is to make an informed decision after studying market conditions. Under the right circumstances, choosing a variable rate may actually help you save a significant amount on accrued interest.

We hoped you enjoyed this article! Remember, you can and potentially lower your monthly student loan payments and save money.