What you need to know about choosing a fixed-rate or variable-rate student loan in 2017

Interest rates are an important concept to wrap your head around if you’re considering taking out or refinancing student loans, especially when given the option to choose between a fixed or variable interest rate.

First off, an interest rate is the amount charged by a lender for the use of the money you are borrowing. Broadly speaking, the interest rate is an annual rate you pay on your outstanding loan balance. If you start out with a $10,000 loan balance at an annual interest rate of 5 percent, you’d expect to pay about $500 per year in interest.

Charging interest is one of the main ways that lenders make money. Additional loan expenses — such as origination fees or monthly service charges — can be factored into what’s known as your effective annual percentage rate (APR).

Private lenders try to charge enough interest to compensate for the fact that some people they lend to won’t pay them back. In addition to pricing in risk of default and other expenses, private lenders try to build in a profit margin that makes them competitive with other lenders.

Depending on the type of student loan you take out, you may be offered a choice between a fixed or variable interest rate loan. The difference is simple: the rate on a variable interest rate loan can change over the life of a loan, whereas a fixed rate will remain the same unless you refinance it.

Rates on government student loans are always fixed, and don’t take into account the credit risk posed by the borrower. That can be a good thing if you have little credit history, or would be considered a high-risk borrower by a private lender.

If you have good credit however, you may qualify for better rates from private lenders — particularly once you’ve graduated and are earning a good income. Check out the table below to see fixed and variable interest rates for top refinancing lenders.

Best refinancing lenders: fixed vs. variable interest rates

Student loans pros and cons

• Federal, private, and ParentPLUS loan refinancing and consolidation

• Fixed and variable interest rates

• Undergraduates: $10,000 - $90,000

• Graduates: up to $225,000

• Dentists, Medical Doctors, and Lawyers: up to $300,000

• Minimum household income of $24,000

• Eligible programs include associate through graduate degrees

• No degree required

Student loans pros and cons

• Federal, private, and ParentPLUS loan refinancing and consolidation

• Fixed and variable interest rates

• Undergraduates: $5,000 - $150,000

• Medical graduates: up to $250,000

• Minimum household income of $75,000

• Available to all US residents that attended an eligible school

• Must have a bachelor's degree or higher

Student loans pros and cons

• Federal and private loan refinancing and consolidation

• Fixed and variable interest rates

• Must be a US citizen or permanent resident or have a co-signer that is a US citizen or permanent resident

• Any Title IV school is eligible to refinance with Connext

• Undergraduate and graduate student loans are eligible

Student loans pros and cons

• Federal, private, and ParentPLUS loan refinancing and consolidation

• Fixed and variable interest rates

• No minimum household income

• Must have a completed degree from an eligible college or university

• All Title IV accredited schools are eligible

Student loans pros and cons

• Federal, private, and ParentPLUS loan refinancing and consolidation

• Fixed and variable interest rates

• Minimum household income of $30,000

• Eligible programs include any title IV degree-granting college and university

Student loans pros and cons

• Federal, private, and ParentPLUS loan refinancing and consolidation

• Fixed and variable interest rates

• Undergraduates: $10,000 - $150,000

• Graduates: up to $250,000

• Minimum household income of $24,000

• Must be employed for at least two years

• Must have graduated from an iHELP eligible

Student loans pros and cons

• Federal, private, and ParentPLUS loan refinancing and consolidation

• Fixed and variable interest rates

• $10,000 up to any amount

• Minimum household income of $24,000

• Eligible programs include associate through graduate degrees from not-for-profit institutions

• Out of school borrowers and borrowers without degrees are eligible

Student loans pros and cons

• Private, state-based and PLUS loan refinancing and consolidation

• Fixed rates only

• Undisclosed loan limits

• Minimum household income of $40,000

• Residents of any state are eligible to refinance

For variable- and fixed-rate loans offered by private lenders, interest rates will typically depend on the length, or term of the loan, and the perceived credit risk of the borrower. All other things being equal, the shorter the loan term, the lower the rate.

While rates on variable interest loans typically start out lower than those for fixed-rate loans, they are also less predictable. Let’s dive a little deeper.

You can learn more about the best refinancing and consolidation companies, and the rates they offer, here.

Pros and cons of fixed vs. variable interest rate loans

Many college and personal finance advisers recommend that you minimize your college expenses and take advantage of all available aid, scholarships and federal student loans available to you before turning to private lenders.

Since all new federal student loans are fixed-rate, you may never have to contemplate the pros and cons of fixed- and variable-rate loans. But, if you need to turn to private lenders to refinance or take care of additional school expenses, here’s how to weigh a fixed-rate loan vs. a variable-rate loan.

Fixed interest rates are usually set at the time of your agreement and don’t change for the life of your loan. The advantage is that you always know how much you will be paying.

The downside of a fixed-rate loan is that you might be passing up the chance to start out making lower monthly payments. Rates on variable-rates loans are lower than fixed-rate loans because you, not the lender, are taking on the risk that rates will increase.

Although they’ve been heading up recently, student loan interest rates remain low by historic standards, so a fixed-rate loan might be a safe bet. Rates are unlikely to get much lower, and if they keep going up, the savings you might start out with by choosing a variable interest loan could evaporate.

If interest rates happen to be high when you take out a fixed-rate loan and end up falling, you might be able to refinance your loan in order to take advantage of the savings. But to make refinancing worthwhile, interest rates would have to fall far enough for you to recoup the expenses that you may incur when refinancing.

Variable rates can either work for you or against you. During tough economic times, the Federal Reserve and other central banks reduce short-term interest rates in the hopes of encouraging lending that can kick-start growth. When the economy shows signs of heating up, the Fed starts worrying about inflation, and policymakers may decide to raise rates in order to keep prices from rising too sharply.

Variable-rate loans are typically indexed to reference rates, which are benchmarks like the prime rate or the London Interbank Offered Rate (LIBOR) that fluctuate with the economy. The lender will add a margin on top of the reference rate that’s aimed at offsetting the risk that the borrower won’t repay the loan and to make a profit.

Basically, the greater your perceived credit risk at the time of the application, the greater the margin (a co-signer can help lower the rate). When central banks make adjustments that raise or lower the cost of short-term borrowing, other rates will follow, including the interest rate on your variable-rate loan.

Variable-rate loans may adjust monthly, quarterly or annually. Some come with a periodic cap limiting how much your rate can increase during each period. Others may also have lifetime caps limiting how much the rate can go up over the life of the loan.

As the chart below demonstrates, the two most commonly used reference rates for variable-rate student loans — LIBOR and the prime rate — can swing dramatically in a relatively short period of time.

The gray bands in the chart above represent recessions. Interest rates plunged in 2008, when policymakers took drastic measures to stimulate growth in the wake of the mortgage meltdown and global recession.

It took some time for those measures to take effect, but Fed policymakers have been gradually raising rates since December 2015. Although interest rates have seemingly little leeway to move in any direction but up, it’s hard to predict when, or how fast, they’ll rise.

The historical chart above can’t tell you where interest rates will be in the months or years ahead. But it can give you an idea of how far they can swing, and how fast. Pulling the slider bar on the chart lets you look back farther in time.

If you’re not sure which loan is right for you, Credible makes it easy to compare rates from top lenders.

The interest rate environment: why rates are so low right now

In December 2015, as the U.S. continued on the road to recovery from the Great Recession, the Fed raised its target for a key short-term interest rate (the federal funds rate) for the first time since 2006.

Although the decision worried some borrowers, the Fed makes changes gradually. Since its initial nudge, the Fed has increased the federal funds rate just three times — once in 2016, and twice so far in 2017. Each increase has been one quarter of a percentage point. So from 2008 through August, 2017, the federal funds rate has increased by only 1 percentage point

Borrowers who already have federal student loans won’t see any difference in their rates from these rate inreases, since rates on federal loans are fixed for the lifetime of the loan (remember our pros and cons table!).

Rates on government loans issued from July 1, 2017 through June 30, 2018 will range from 4.45 percent for undergraduate loans to 7.00 percent for Direct PLUS Loans issued to parents and graduate or professional students. If you’re planning to take out federal loans after that though, you might pay higher interest rates.

Rates on federal loans are determined by Congress, and can depend not only on how the economy’s doing, but political sentiment. Since a 2013 overhaul of the Higher Education Act, interest rates on federal direct loans are set annually, according to a formula that uses rates for 10-year Treasury notes as a benchmark.

Rates for all federal student loans increased by 0.69 of a percentage point on July 1, 2017. To determine the rate for undergraduate loans the Department of Education tacks 2.05 percentage points onto the rate for 10-year Treasury notes auctioned in May. The add-on for federal direct loans for graduate school students is 3.6 percent, while rates for PLUS loans will be equal to the 10-year Treasury note yield plus 4.60 percentage points.

So if you’re wondering where rates on government loans might be headed in years to come, keep your eye on the 10-year Treasury note. If rates on 10-year Treasury notes go up or down, so will rates for new federal student loans.

As the chart above demonstrates, long-term rates like 10-year Treasury notes don’t always track short-term rates like LIBOR exactly, but there’s a correlation. Note how during the last 20 years, long-term and short-term interest rates both took a dive in 2001 (in the aftermath of the dot-com bust) and 2008 (in the wake of the housing crash), and stayed depressed for a while.

If you had to guess, which way would you say interest rates are headed next?

Pull the slider bar on the chart to go back even farther in time, and you’ll see another pattern in long-term rates during the last 10 recessions (represented by gray bars) stretching back into the 1950s.

If you’re younger than 40 or 50, check out the inflationary period in the 1970s. It might be a revelation that when oil prices and government borrowing are running rampant, interest rates can go UP during a recession (1974). And take note that rates on 10-year Treasurys are ultimately driven by markets. They can get into the double digits, even if nobody really wants them to be that high.

There are two caveats about rates on government student loans to keep in mind: First, the formula mandated by the Higher Education Act imposes an 8.25 percent cap for federal direct loans to undergraduates, and 9.5 percent for direct loans to grad student loans. The cap for PLUS loans is 10.5 percent.

Second, there’s no law that says Congress can’t change the rules that determine government student loan rates again. If rates on 10-year Treasury notes soar, lawmakers — particularly Democrats — may be reluctant to let rates on government loans approach the currently mandated caps. Some Republicans who champion market principles might argue that rates should be allowed to exceed the caps.

How do fixed and variable interest rates affect you?

Life would be easier if you could predict whether interest rates were going to rise or fall, and when. But of course, you can’t — so how do you decide whether a fixed or variable rate might be better for you?

Generally speaking, this depends on how risk-averse you are. If you’re relatively comfortable with uncertainty, or are fairly confident that interest rates aren’t going to dramatically increase, you could consider a variable rate. A variable interest rate might also work for you if you think you might be able to pay more than just the minimum amount every month, thereby shortening the length of your loan.

If you know you’ll need to borrow a lot of money to graduate from college that will take many years to repay, a fixed-term loan at today’s interest rates could be a real bargain in a decade or two. Because inflation will probably erode the value of the dollar — and pump up your paycheck — a fixed-rate loan should get easier to repay over time.

The good news is that if you’re in a variable-rate loan that starts to get more costly, it’s often possible to refinance into a fixed-rate loan.

Find out if you qualify for a lower rate by comparing your options with Credible. Y ou can compare offers from a variety of vetted lenders, without having to share any sensitive information, or incurring a hard credit pull.

Ariha Setalvad <[email protected]; is a Credible staff writer. Follow us on Twitter at @Credible.

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Pros and Cons to Pursuing a Federal Student Loan Consolidation

In 1992, the program for federal student loan consolidation was created. The act was created under George H.W. Bush as part of the Higher Education Act. The program underwent sweeping changes in 2010 under Obama and has been referred to the Obama Student Loan Forgiveness program. The legislation allows for the cancellation of debt in certain cases and gives help with existing balances.

There are many factors that would lead a person to consider consolidating their student loans under a federally offered program. Issues like the unsteady job market and disabilities can often affect a person&#8217;s ability to pay back their loans, making a merger an attractive choice. There exist both pros and cons to this option, and we wish to cover these within the scope of this article.

  • Student loans pros and consConsolidation Simplifies Repayment Process: Instead of having multiple accounts with different lenders and varying interest rates, borrowers will have just one account with one lender and percentage. This will make tracking due dates and balance information easier, ensuring customers will be able to pay on time.
  • Payments Are Flexible: Monthly remittances can be adjusted according to changes in life circumstances, and if the government deems the person unable to pay, their amount due can go to as low as $0.00 per month. This is not considered a deferment but is deemed the actual dollar amount required. The mandatory monthly total can also change to reflect the size of the client&#8217;s family.
  • Unpaid Balances Can Be Cancelled: An appealing part of refinancing using this method is that customers are forgiven any monies still outstanding at the end of their term. This is a strong departure from the traditional methods of consolidation. Many people still have large amounts due on their conventional loans after paying on them for a significant length of time. This can make getting a home difficult as well as starting a family. The money written off with a government loan can potentially be a large sum.
  • A Fresh Start: There is a certain mindset that occurs when a person has been in default and has a negative credit rating. They often leave off paying, as they perceive there is no longer any reason to try to improve their situation. A new beginning and a clean slate can give people the inspiration to begin working to pay down their bill again.
  • Older Arrangements May Qualify: Some older loan types are included under the REPAYE system, meaning that these also can be eligible for refinance. The original PAYE program only worked with financing taken out later than 2007 until after a revision was made to the regulations.
  • Student loans pros and consInterest Rate Increases: Unlike with a private financial institution, a person&#8217;s rate of interest is not going to decrease when seeking to join their accounts into one. The government takes the previous amount charged and will add around 0.125%.
  • Term Lengths May Be Longer: The number of years it will take to repay is dependent on the total monies requested. A scale exists with smaller sums from less than $7,500 to $19,999, taking from 10 to 15 years to complete. Monetary values of $20,000 to over $60,000 can be paid from between 20 and 30 years.This means that a person may end up paying on their balance over a longer period of time by choosing this method.
  • It May Decrease the Ability to Pay Off: The ultimate goal is to pay the original balance in full, and this may be hindered if the interest rate and number of years are both increased.

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7 Primary Pros and Cons of Consolidating Student Loans

The class of 2014 has the highest amount of student loan debts. According to a government analysis done by Mark Kantrowitz, publisher of a group of websites about planning and paying for college, Edvisors, the average student has to pay back an estimated $33,000. So, instead of looking back at your college life with appreciation and happy recollection, you would be worrying about how to pay your debt and for how long you would have to struggle with it.

So why not consolidate your student loan? Consolidation is said to make your life easier, especially if you owe money from 5 to 10 separate lenders. Other people, however, would disagree, saying there are negatives to this process.

1. Single payment to worry about

In a nutshell, consolidation is one lender, one payment. All your federal loans will be combined into one and serviced by one lending institution. So, instead of several debts, you will only have one loan that will require a single monthly payment. If you have other loans to deal with, student loan consolidation will mean one less problem to worry about.

Different lenders are likely to have different interest rates. When inflation happens, each of your loan has to be adjusted, which can be stressful, especially if you think about the changes in your repayments. When you choose to consolidate, interest rates on all your loans will be averaged and then rounded up to the nearest 1/8 of 1%.

Through consolidation, you have a chance to get reduced interest rate and lower your monthly repayment. This is because your loan terms can be extended from 10 up to 30 years. Who doesn&#8217;t want an affordable loan that you can repay as you go along in life? Know though that longer payment terms may mean higher interest rates.

4. Better deferment or forbearance options

A federal consolidation loan will be considered a new loan, which means you start from square one in terms of deferment and forbearance for up to 3 years. You can even delay paying for up to three years, if you apply for unemployment or economic hardship deferment, in the event that you are still unable to find employment.

1. Only available for federal student loans

If you borrowed money from private lenders or institutions, you can&#8217;t take advantage of the federal consolidation loan program that has a more affordable interest rate. The good news is there are now private student loan consolidations available, but you must have a credit score of 50 to 100 points, or more, to be eligible.

2. Loss of certain benefits

Whatever benefits that came with your student loan, you will likely lose when you consolidate. Take for instance Perkins Loans. When it becomes part of Federal Consolidation Loan, a teacher will lose the option to have 100% of her loan canceled, if she meet certain conditions. Can you imagine giving up a potential 100% loan cancellation?

Typically, you only start making repayments six months after your loan was released. When you consolidate your student loans, however, you will lose this particular benefit, since you have to start paying two months after consolidation is approved.

PRO: Parent PLUS loans are made to parents and have much higher limits.

The obvious thing that separates Parent PLUS loans from other federal loans is right in the title. Unlike all other government loans, these loans are made directly to the parent, and the student is not liable for repaying the loan. This means that if your child has a wrecked credit score, loans can still be acquired. It is also an option for parents who want to pay for their child&#8217;s education, but lack the funds to do so entirely.

Due to the high borrowing limits, these loans are also often used to cover the remainder of the college costs when scholarships, grants, and other federal loans are exhausted.

Parent PLUS loans have higher interest rates than any other federal loan. What makes this fact somewhat surprising is the relative risk. Normally interest rates go up or down according to how much risk there is with the loan. Risky loans have high interest rates and the loans that are more likely to get paid back have lower rates. One would expect money lent to parents, who already have jobs and a credit history, would be less risky than money lent to a recent high school grads. Unfortunately, the federal government treats these loans differently and by statute they have higher rates than those given to undergraduate and graduate student loans.

Parent PLUS loans are eligible for the Income Contingent Repayment Plan (ICR). The nice part about this repayment plan is that it is based upon the income of the borrower, not the total loan balance. For those borrowers who have an unexpected job loss, the ICR plan ensures that they can stay current with the loan. ICR requires that borrowers pay up to 20% of their discretionary income towards the loans.

Similarly, there are provisions to have the loans forgiven after 25 years of ICR payments and possibly even as soon as 10 years for public servants.

CON: Repayment Limitations and Consolidation Confusion

A major downside to the Parent PLUS loans is that they are not eligible for the best income driven repayment plans. Where ICR requires 20% of a borrower&#8217;s monthly discretionary income, other plans require as little as 10%. This can make a huge difference in the monthly payment.

Another downside is that qualifying for some federal benefits, such as Public Service Student Loan Forgiveness, requires the Parent PLUS loan to be consolidated into a federal direct loan once it is in repayment. Not only is this extra step a headache, it can also result in some major mistakes. If a Parent PLUS loan is consolidated with other federal loans, the new large consolidated loan has the same limitations as the Parent PLUS loan. A mistake here can double the payments on many of the other federal student loans.

As a result of the current rules, many borrowers stand to gain a lot by federal consolidation, but if they include the wrong loans within the consolidation, they could be making a huge mistake. Worst of all, many of the federal loan servicers do not understand the implications of combining a Parent PLUS loan with other federal loans.

There are advantages to Parent PLUS loans, but there are some major drawbacks as well. The most important thing when it comes to dealing with these loans is understanding that they are different. Some of the general rules of federal loan management apply to these loans, but there are some major exceptions that cannot be ignored.