Since the amendments to the Higher Education Act in 2002, the federal government has changed its interest rate repayment structure, requiring borrowers to repay loans at a fixed (as opposed to variable) interest rate. Recently, several private lenders, such as Wells Fargo and Sallie Mae, have also started to offer fixed interest rates as an option to borrowers. In order to make an informed decision about which loan is right for you, it’s important to know the facts.
So what exactly is the difference between fixed and variable interest rates?
Fixed Interest Rates
With fixed interest rates, borrowers know exactly how much interest they will be paying for the length of their repayment, and thus, can plan exactly how much they need to put aside each month to repay their loans. For a borrower taking out a $10,000 loan, they know that they will be repaying their loan at an interest rate of, say, 7% – roughly $89 per month – for 15 years. Even if Congress passes a bill to raise the interest rate, they will still be locked in at an interest rate of 7% for the remainder of the repayment term.
While fixed rates may initially be higher, there is no risk of your rate increasing over time.
Variable Interest Rates
Availability: Private loans
If you’re the type of person who is more interested in taking smaller, calculated risks, then variable interest rates may be what you are looking for. Variable interest rates are based on the prime or LIBOR (London Inter Bank Offering Rate) plus a set margin that is determined by the loan lender at the time of approval, and is based on your credit score and credit history. Here is an example of a deconstructed rate:
3.25% (the current prime rate) + 2.25%(a margin based on credit) = 5.50%
The prime and LIBOR rate indexes are adjusted every few months or so, making variable-rate loans fluctuate accordingly. This is why variable rates may be riskier than fixed-rate loans.
While it’s important to compare lender interest rates to find your best options, also compare Annual Percentage Rate (APR). The APR is usually a more accurate picture of a loan’s overall “cost” because it takes other associated fees into account.
Ultimately, the choice between fixed or variable rate comes down to your preference. Would you rather lock in your interest rate or risk a potential rate increase in the future?
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