Choosing a loan with a variable rate could save borrowers money if interest rates stay low for the life of the loan. On the other hand, borrowing with fixed student loan rates could offer some predictability when planning student loan repayment.
What is a fixed-rate student loan?
For most students heading to college, a fixed rate student loan means a federal student loan. The U.S. Department of Education offers a number of these, including Direct Subsidized and Unsubsidized Loans and PLUS Loans, all of which have a fixed interest rate. Interest rates for these loans are determined annually by Congress.
What is a variable rate student loan?
Variable-rate student loans are ones offered by private student loan lenders. A variable interest rate is tied to an underlying benchmark rate, such as the prime rate. When the underlying index rate increases or decreases, the interest rate assigned to a variable rate student loan can follow suit.
When a variable rate loan makes sense
There are some scenarios when a variable rate could work in a borrower's favor in repaying education debt.
"A major pro of having a variable rate student loan is that your initial rate can often be much lower in the beginning than a fixed student loan rate would be," said Robert Farrington, creator of The College Investor. "If you plan to pay off your student loans quickly, you'll be able to take advantage of these lower rates."
This assumes that you've developed a game plan for repaying student loans in the shortest amount of time possible. Paying loans off faster is an obvious choice if you're concerned with saving on interest charges.
Additionally, a lower rate could translate to lower monthly payments. That can free up money in your budget for other purposes.
For example, one of your financial goals after college may be saving money for a down payment on a first home. A variable rate loan could help you in reaching that target if the rate - and payment - remains low.
When a fixed-rate student loan could be the better option
The key thing to keep in mind with variable rate loans is that rates aren't set in stone.
"Rates can change monthly, quarterly or yearly, depending on the loan," Farrington said. "If you're only able to make the minimum monthly payments, these can change drastically and often, which can be detrimental to those on a tight budget."
Fixed student loan rates may be preferable for borrowers who want certainty in the amount they'll repay monthly and total over the life of the loan. While the rate may be higher compared to a variable rate loan, there are no surprises. And borrowers can still net interest savings by paying more than the minimums each month to accelerate their loan payoff.
Weigh loan options carefully
Whether to get a variable-rate student loan or a fixed-rate loan really comes down to whether you want to pursue federal loans, private loans or both. While federal loans have fixed rates, private lenders can offer variable or fixed-rate loans. You may be given a choice of rate options when you initially apply for a private student loan.
Remember that when getting an installment loan to pay for school from a private lender, credit history comes into play. A co-borrower may be necessary to qualify for the lowest rates, whether fixed or variable.
Consider also whether you're able to take advantage of a grace period in which no payments are due on your loans. Federal loans offer a six-month grace period after graduation, while private lenders aren't required to offer this benefit.