Everything You Need To Know About How Variable Rate Student Loans Work

Everything You Need To Know About How Variable Rate Student Loans Work

August 12, 2020 11 By mindmingles

Deciding to go to college involves making some decisions that affect every aspect of your life moving forward. This doesn’t just include the major you choose or the state you’re moving to; it should also take into account the financial implications of taking out student loans work.

According to Forbes, it can take up to 18.5 years to pay off student loan debt. Considering that you’ll be stuck with these loans for the years to come, you should make sure to learn everything there is to know about student loans before you dive in.

One term you’ll come across in your research is “variable rate.” This is one of the two options at your disposal when deciding which loan plan you want to go with.

Today, we’re looking into how variable-rate Student Loans Work and all there is to know about them.

What are they?

Variable-rate, also referred to as floating rate, is the interest rate charged on the outstanding principal loan amount. As the name suggests, these interest rates are prone to fluctuation over time.

Throughout the loan’s lifetime—no matter how long it takes to repay it—the interest rate will face adjustment depending on the market. Unlike fixed rate loans, variable rate loans don’t offer as much constancy in monthly payments. While fixed rates seem like an obvious choice to many who seek predictability and stability, variable rate loans can lead to greater savings.

Currently, all federal loans are based on fixed rate interest but private lenders allow you to choose between the two.This is owing to the change inJuly 2006 whenfederal student loans moved away from variable rates and opted for only fixed interest rate loans.

Given that your future finances are at stake, you shouldn’t just write off variable rate interest loans. Instead, this can be a viable option for people looking to pay off their loans and enjoy some savings!

A young woman using her laptop to research loan options

How is the interest rate determined?

The interest rate of your loan doesn’t just determine how much money you’ll spend every month, but also the total amount you’ll spend to pay off your loan. Hence, knowing how variable rates function can help you understand what you’re signing up for beforehand.

Private lenders offering variable interest rate loans often tie it to an index rate. This helps them figure out the direction of the rate’s movement. If the index rate increases or falls, the interest charged on your loan will move in the same direction.

The LIBOR (London InterBank Offering Rate) is often used as the index by many lenders. This is the rate banks use to charge each other on overnight loans. As the LIBOR rate changes, the variable interest rate charged on your student loan does too.

However, your variable rate isn’t the same as the LIBOR rate; it’s often a certain percent more than it. This means, for instance, if the LIBOR rate is 4%, your loan interest rate will be 6%.

Depending on the term of your student loan, the variable rate may change accordingly. It can range anywhere from monthly changes to yearly ones.Once you’ve narrowed down the lender you want to work with, they’ll inform you of the timing of the rate change.

A student speaking to potential lenders on the phone and taking notes on her tablet

Is a variable interest rate loan right for me?

The thought of variable interest rates may seem daunting to many, but there are considerable benefits of opting for this type of student loan. Since student loan payments tend to span anywhere between 5–20 years, you should aim to repay your loans as quickly as possible.

Determining whether variable interest rates on student loans work right for you relies on assessing the pros and cons they offer.

They’re less expensive at the beginning

When you borrow to finance your education, your lender takes on the risk of providing money to you in the hopes of receiving it in full (plus the interest). However, variable interest rate loans also place you in a possibly risky position since the interest rate will fluctuate over time.

Hence, you’re compensated for taking on this risk by receiving a lower starting interest rate compared to fixed-rate Student Loans Work. This allows you to make larger payments at the start of your loan repayment term in the hopes of reducing the principal amount you owe.

They’re risky

It’s no surprise that your loan’s interest rate can change the cost of your loan entirely. This is especially true for variable rate loans that experience interest rate fluctuations over time.

Knowing the inherent risks involved before you dive in is necessary to determine whether they’re right for you. If interest rates increase considerably over your repayment term, you could end up paying back a lot more than you’d anticipated. However, when rates fall—such as the unprecedented near-zero interest rates in the aftermath of COVID-19—you can enjoy much lower monthly and total payments.

Meeting with a consultant to understand loan terms

You can save some money

When you take on the risk that comes with variable interest rates, you also get to enjoy the reward. This comes in the form of lower interest rates leading to incredible savings.

While fixed interest rate loans mean you’re stuck making a certain amount of savings every month, variable rates result in fluctuating monthly savings. The volatility of interest rates can result in dramatic decreases that’ll translate to lower monthly payments. Taking a look at the LIBOR rate history will give you a clearer picture of how rates may change, making it easier to decipher whether you stand to make a profit or not.

They’re great for short-term loans

Many people prefer to gradually repay their student loans over a standard 10 or 20-year payment plan. In such circumstances, a variable rate loan can be detrimental toecome the reliable and established lending service ofyou. Over this long span of time, the variable interest rate may change drastically and leave you paying back hefty monthly amounts.

Instead, if you’re looking to pay off your loans within 3–5 years, variable interest rates are perfect for you. Since interest rates may not change as much in such a short time, you could easily pay off your loan and enjoy the lower interest payment.

A final word

Student loan terms can impact your personal, professional, and financial future, so make sure you make the right decisions. The good news, you don’t have to be stuck with unfavorable loan terms forever.

Student loan refinancing offers a viable way to change your loan terms and take advantage of the financial environment at the time. Working with Education Loan Finance’s student loan refinancing experts, you can figure out whether you should opt for fixed rate or variable rate loan refinancing, and so much more!

About Education Loan Finance

Education Loan Finance is one of the leading providers of parent loans, student loans, and refinancing options in the U.S. By providing favorable payment plans and low interest rates, ELFI has become a reliable and established lending service of choice for many.