Fixed vs. Variable Rate Student Loans

When searching for private student loans, you may find some lenders offer both a fixed and a variable rate option. What does this mean, and what are the pros and cons of each?

Fixed Interest Rate

A fixed rate loan is exactly as it sounds – the interest rate is fixed, or stays the same, for the entire life of your loan. Rates are currently low, so this could be a good time to choose a fixed option and lock it in.

• PROS: You’ll know what your interest rate is, and consequently what your payment will be and won’t have to worry about fluctuations down the road.
• CONS: The tradeoff for knowing what your rate will be for the long haul is that it is often a higher rate than a variable rate option.
• Who should consider a fixed rate: In general, most borrowers will benefit from a fixed rate loan if only from a budgeting standpoint. This is especially true in a rising rate environment. But remember if interest rates decrease later, you’ll retain the rate you locked in unless you refinance your loan(s).

Variable Interest Rate

When you select a variable rate loan, your interest rate will fluctuate over time based on the current index rate. (The Prime Rate is the underlying index used to determine the base rate for most loans.) Your lender adds a percentage to that base according to your credit score and history, and there is usually a limit or “ceiling rate” on how high your rate can go if the Prime Rate increases, or a “floor rate” on how low your rate can go if the Prime Rate decreases.

• PROS: Variable rate options are typically lower than fixed rate at the start of your loan. Additionally, if the index decreases in the future, so will your interest rate.
• CONS: There is risk involved; while your rate could go down, it could also increase, meaning you will pay more in interest over time.
• Who should choose a variable rate: If you feel confident in your ability to continue to make payments regardless of a potentially higher interest rate, you plan to pay your loans off quickly, or it’s a decreasing rate environment, you might want to consider a variable rate.