Taking out a loan is a big step. It’s the step in life that will change your future. Many times, the first big loan you’ll take out will be a student loan or a home loan. Unfortunately, you may feel unprepared and unsure of what to expect when you go in to speak to a lender. It’s necessary to understand the difference between two types of loans before you go in; fixed and variable interest rate.
Which Is Right for Me?
There are many factors that will help you decide which loan will suit you. You’ll want to take into consideration what is right for you and what is right at this time. Some things to consider are:
- Long-term vs. short-term commitment: Do you plan on paying your loan off early or plan to pay the loan for the entirety of the term?
- Goal – Savings vs. Budget: Is your main goal to have the lowest monthly payment or you want to minimize the interest paid over lifetime of the loan?
- Improving income or credit profile:Will your salary or credit profile improve in near future? Do you want to lock a rate now or do you want to refinance to a low monthly payment in the interim before locking a rate?
- Market conditions: Are interest rates low and expected to stay low or are they high? You don’t need to be Nostradamus to figure this out, a simple Google search will give you the common consensus out there on interest rate.
- Staying on top of things: Are you too busy to check rates once in a while and prefer to commit to something and be in auto-pilot? Can you commit to checking rates once or twice in a year and refinance again when rates fall, you get a raise, or your credit profile improves?
Fixed Interest Rate
A fixed interest rate is one option you’ll be presented with when it comes to taking out a loan. The interest and monthly payment will be the same. Whitney Barkley-Denney, senior policy counsel for the Center for Responsible Lending, writes in a US News article, “A fixed rate student loan is positive because you know what to expect.” The predictability of a fixed rate comes at a cost – the interest rate you will get for fixed rate loans will be higher than equivalent variable rate loan from a lender so you end up paying thousands more in interest payments over the lifetime of the loan when compared to a variable rate loan with similar terms.
You want to be sure that you’re not planning to pay off a fixed rate loan much sooner than the term of the loan. If so, you would be better off going for a variable rate loan and saving on interest. There are many things that can trigger a pre-payment from improving salaries to falling loan rates that may lead you to refinance your loan again.
A student loan calculator is an excellent tool to incorporate in the borrowing process to understand the big picture of a fixed rate loan. There are many student loan calculators out there like ones at CNN Money and the New York Times.
When Fixed Rate loans might be better:
- Long Term Commitment: If you don’t plan on paying your loan off early.
- Savings is the main goal: If your primary goal is to minimize interest payments over the life of loans.
- Stable salary or credit profile: If you feel that your income or credit profile is pretty stable, lock in a fixed rate. On the other hand, if you feel that either your salary or credit will improve in near future, go with a variable rate first and then lock in a fixed rate when you get that raise or improve your credit score.
- Low or falling interest rates: If interest rates are low and expected to rise, it can be beneficial to lock in the fixed rate.
- Can stay on top of things: If you’re too busy to check rates once or twice in a year and would prefer to commit to something.
Variable Interest Rate
On the other hand, a variable interest rate loan will change with the conditions of the market. If market interest rates increase, so will yours, but, if they decrease, you will pay less. Variable interest rates aren’t as scary as they sound, the rate is based off an index that your bank uses. In addition to that, there will be an established cap that the interest rate cannot rise above. You won’t see sudden spikes or decreases in your payments; the interest will rise or fall slowly.
You will pay less in interest with a variable rate loan than an equivalent fixed rate loan, however there are few things to watch. You’ll have to keep an eye on interest rate, checking once or twice a year is suggested. Remember, if you go with variable and it’s not a good fit, you can always refinance to fixed. Student loan refinancing with most lenders does not involve any upfront fee.
When Variable Rate loans might be better:
- Short Term: If you think you’ll be able to pay your loan back sooner than the full term of loan.
- Tight Budget: If you are on a tight budget, interest on variable loans can be considerably lower than a fixed rate.
- Future Market Conditions: If interest rates are predicted to stay steady or decline over the duration of your loan, you could pay less in the long run.
- Expect higher salary or better credit profile: If you expect a salary raise or if you expect your credit score to improve and you’ll qualify for a lower rate loan. In such situations, you can start with variable and switch to fixed rate when your personal situation improves.
- Can keep tab on rates:If you have the time to check interest rates few times in a year. If you have a goal to save more money (most people do) and are not worried about small changes in payments over time.
The best choice for you can come from finding the appropriate lender. One such place to find that student loan refinance loan suited to your needs is Lend-Grow. Lend-Grow connects borrowers with a network of local lenders that compete to offer refinance loans. “Not all lenders are created equal. Some offer better rates on fixed rate loans while others are more aggressive with variable rate loans. Some are more suited for undergraduates while others are focused on refinancing graduates. Lenders also differ on competitiveness by credit segment – some will offer better rates for borrowers with good credit while others offer competitive rates for borrowers with excellent credit” says Nish Krishna, the founder of Lend-Grow.