When you apply for refinancing, most lenders will give you the option of choosing between fixed and variable interest rates. No one option is best for everyone. Each has their own sets of pros and cons. Understanding the differences between the two will help you make the right decision for you. Keep in mind, that interest rates greatly impact your student loan so really take the time to learn about them.

Let’s break down the main differences between fixed rates and variable rates.

How Fixed Rate Works

Fixed interest rates are fixed for life. When you choose this option, the interest rate is locked at the time you take the loan. That rate remains unchanged throughout till you pay off the loan completely. Your monthly payments also remain the same till the end of the loan term. There are no surprises when you choose this option.

Fixed interest rates are typically higher than variable rates but they also protect you against potentially higher rates down the road.

Pros and Cons of Fixed Rates

Pros

• Interest rates remain consistent throughout the loan term – You are ‘rate-protected’ when you choose a fixed rate. Even if market conditions change and loan interest rates increase, the interest rate on your loan won’t change.
• Monthly payments also remain consistent for the life of the loan – Your interest rate and repayment term are set at the time of taking the loan. The monthly payments are then spread equally over the term of the loan. Since the interest rate stays the same, the payments also stay the same every month.
• Easier to calculate the total repayment cost – With everything remaining constant throughout, it’s easy to calculate exactly how much the loan will cost you.
• Easier to set a budget – Knowing how much your monthly debt is and that it’s not going to change can be a good thing. It makes it easier to create a budget and better manage your finances.

Con

• Higher rates at the start of the loan – Fixed rates are usually higher than variable rates at the start of the loan.
• Potential loss of benefits – You won’t benefit from potentially lower rates if markets go down.

How Variable Rate Works

Variable interest rates are based on market conditions. Rates are lower when markets are down and higher when markets are strong. This means the interest rates could fluctuate repeatedly during the term of the loan.

Variable interest rates usually start out lower than fixed rates. However, that lower rate is not guaranteed. There’s a chance that the rate could increase or decrease significantly over your loan term. You could benefit from the lower rate, but you could also end up paying a higher rate. If the rates change, your monthly payments will also change.

Pros and Cons of Variable Rates

Pros

• Lower interest rates at the start of the loan – At the time of signing the loan, variable rates are considerably lower than fixed rates.
• Potential lower rates from weak market conditions – 2020 is a prime example of this. The pandemic resulted in a huge market shifts and interest rates dropped sharply. Anyone who refinanced with variable rates benefited significantly from the lower interest.

Cons

• Interest rates are not guaranteed – You are not ‘rate-protected’ when you choose a variable rate. The rate is pegged to market condition. You have to be prepared for periodic fluctuations on your rate, which could be higher or lower than your sign-up rate.
• Monthly payments are inconsistent – Your monthly payments increase or decrease depending on prevailing interest rates.
• Difficult to set a long-term budget – You’ll have to keep adjusting your budget every time the interest changes. This can be particularly unsettling for some people.
• Not possible to calculate the loan repayment cost – With all factors changing consistently, it’s difficult to calculate exactly how much the loan is going to cost you.

Is Fixed or Variable Rate Right for You?

As with all financial decisions, there’s no one option that’s best for everyone. The better option for you will depend on your current financial circumstances and your financial goals. Your risk threshold is also something that will factor into your decision.

A fixed interest loan may be the better option for you if:

• You prefer a longer repayment term
• Indexes and interest rates are on the rise
• You like the certainty of consistent monthly rates and want to set a long-term budget
• You have low income and can only commit a certain amount towards monthly payments with no room for adjustments
• You’re unsure about your future income
• You have a low threshold for risk

A variable interest loan may be the better option for you if:

• Interest rates have dropped and are likely to drop further
• Your credit score qualifies you for the lowest interest rate available
• You are looking to pay off your loans as quickly as possible, reducing the impact of rate increases
• You are earning enough and can afford potentially higher monthly payments if necessary

When refinancing student loans, don’t rush into choosing either a fixed or variable interest rate. First consider your financial circumstances, long-term goal, and personal preferences. Also read up on market predictions to get a better idea of whether rates are likely to increase and decrease. Taking all of these factors into consideration will help you make the right choice that could save you thousands in interest over the repayment term.