How To Choose Between Fixed-Rate Vs. Variable-Rate Student Loans

Kat TretinaPersonal Finance Writer

For the past seven years, Kat has been helping people make the best financial decisions for their unique situations, whether they're looking for the right insurance policies or trying to pay down debt. Kat has expertise in insurance and student loans, and she holds certifications in student loan and financial education counseling.

Mike CeteraEditor in Chief, Forbes Marketplace U.S.

Mike Cetera is the editor in chief for Forbes Marketplace U.S. Mike has written and edited articles about mortgages, savings accounts, CD rates and credit cards for more than a decade. Prior to joining Marketplace, his work appeared on Bankrate, The Points Guy and Fit Small Business. Mike earned a master’s degree in public affairs reporting from the University of Illinois and has been a journalist for more than two decades. He also has offered his expertise in numerous TV, radio and print interviews.

Kat Tretina,

Kat TretinaPersonal Finance Writer

Mike Cetera

Mike CeteraEditor in Chief, Forbes Marketplace U.S.

Personal Finance Writer, Editor in Chief, Forbes Marketplace U.S.

Updated: Feb 5, 2021, 5:00am

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How To Choose Between Fixed-Rate Vs. Variable-Rate Student Loans

When you apply for a private student loan or refinance your student loan, you often have the choice between variable and fixed interest rates. Variable-rate loans can be tempting because the advertised rates are so low. But what’s the catch?

In this breakdown of variable- vs. fixed-rate loans, learn about each interest rate type’s differences and advantages.

How Variable-Rate Loans Work

Variable interest rates are only available on private student loans and refinancing loans.

With variable-rate loans, the interest rate on your loan can change—perhaps monthly. They often start with lower interest rates than fixed-rate loans, but the interest rate can increase based on the index the lender uses.

Most private student loan companies use the London Interbank Offered Rate (LIBOR) as their index, although that is expected to change. LIBOR is designed for banks and financial institutions to use when lending to one another, but consumers need to be aware of LIBOR because it can impact the interest rates you get on student loans, mortgages and even business loans.

To calculate your interest rate, private student loan lenders will charge you the LIBOR rate plus their margin. For example, the three-month LIBOR rate as of January 13, 2021, was 0.24%. If a lender had a 3% margin, your interest rate would be 3.24% (0.24% LIBOR + 3% margin = 3.24%).

Keep in mind that the LIBOR rate is at record-breaking lows right now. By contrast, the three-month LIBOR in December 2018 was 2.81%. With that LIBOR rate, your interest rate would be 5.81% (2.81% LIBOR + 3% margin = 5.81%), a significant difference.

With variable-rate student loans, lenders have a cap on how high the interest rate can get. For example, Discover has a cap of 18% on variable-rate loans, meaning your interest rate will never exceed that number, even if the LIBOR skyrockets. The lender’s cap will be listed on the loan application and loan disclosure agreement.

Advantages of Variable-Rate Loans

You can get a lower interest rate. Variable rates typically are lower than fixed-rate loans, particularly at the start of your repayment term. As of January 2021, some lenders are offering variable-rate loans with rates as low as 1.24%.
You might save more money. Since you can get a lower rate with variable-rate loans, you may save more money over the length of your repayment term. With a lower rate, less interest accrues on your loan.
Extra payments will chip away at the principal. If you pay more than the minimum payment required, more of your payments will go toward the principal rather than interest charges since you have a lower initial rate, helping you pay off the loan faster.

Downsides of Variable-Rate Loans

Your interest rate can increase. While variable-rate loans typically start with low rates, there is no guarantee that rates will stay low. If the market changes, you could see your rate increase up to the lender’s cap.
Your monthly payment can go up. As the interest rate on your loan fluctuates, your monthly payments can change as well. If the interest rate increases, your monthly payment can get significantly larger, making it difficult to plan or budget, and it may be more than you can afford.
The total cost of repayment is unknown. Because your rate is not locked in and can change, it’s impossible to know your total cost of repayment. If the rate increases substantially, you could end up paying thousands more in interest charges.

How Fixed-Rate Loans Work

With a fixed-rate loan, you will have the same interest rate for the entire duration of your loan. Instead of using an index like LIBOR to determine your rate, lenders decide your interest rate based on your credit score, income and whether you have a co-signer on the loan.

Federal student loans only charged fixed interest rates, and borrowers all have the same rate regardless of their creditworthiness. Private student loan lenders and refinancing lenders typically offer both fixed- and variable-rate loans.

Advantages of Fixed-Rate Loans

You have a predictable monthly payment. With a fixed-rate loan, your monthly payment will never change, so you can create a consistent budget.
You know exactly how much you’ll repay on your loan. Because the interest rates and payments don’t fluctuate, you can find out how much you’ll repay by simply calculating the sum of the number of payments you have to make.
Your interest rate never changes. The rates on fixed-rate loans remain the same for the life of your loan, so you don’t have to pay attention to indexes or market changes.

Downsides of Fixed-Rate Loans

Your loan may have a higher interest rate than some variable-rate loans. Lenders typically charge higher interest rates on fixed-rate loans than the initial rate offered on variable-rate loans.
You can’t take advantage of market changes. Because fixed rates never change, you can’t take advantage of lower rates—which means lower monthly payments—if the LIBOR goes down. The only way to get a new rate is to refinance your student loans.
You may pay more over time. Because fixed-rate loans could have higher rates, you might pay more in interest charges over the life of your loan.

Variable- or Fixed-Rate Student Loan: Which Should You Choose?

When deciding between fixed- or variable-rate loans, use the following tips to help you choose which is best for you.

When a Fixed-Rate Loan Is Best

You need more time. If you think you’ll need more time to repay your loan—10 years or more—opting for a fixed-rate loan makes more sense than a variable-rate loan. With a longer loan term, it’s more likely that interest rates will go up, so selecting a fixed-rate loan is the safer choice.
You want stable payments. If you’re worried about your monthly payments increasing and want more stability, a fixed-rate loan is a better choice.
You’re worried about interest rate changes. If you suspect that interest rates will fluctuate in the near future, choosing a fixed-rate loan can give you more peace of mind.

When a Variable-Rate Loan Is Best

You believe interest rates will remain steady. If you think market trends indicate that interest rates will remain stable throughout your loan term, a variable-rate loan might be a smart gamble.
You choose a short loan term. With a short loan term, such as five years, large market fluctuations are less likely, so a variable-rate loan can help you save money.
You want to pay off your debt aggressively. If you want to pay off your student loans as quickly as possible and plan to make extra payments, taking advantage of the lower initial rate will help you get rid of your debt faster.

Fixed vs. Variable Student Loan Rates: Student Loan Refinancing

Like other private student loan lenders, student loan refinancing lenders typically offer both fixed and variable-rate loans. You can refinance both private and federal student loans to potentially lower your interest rate, reduce your monthly payment and save money over time.

When refinancing your debt, a variable-rate loan can make sense when you want to pay off your loans ahead of schedule. However, if you have a substantial amount of debt and will need several years to pay it off, a fixed-rate loan might be a better option for you.