Right now, interest rates for student loans are lower than they’ve been for many years. For students, this is great news! Lower interest rates mean that it’s going to cost less to pay off all of your loans. However, private student loan interest rates are generally lower – they could offer even more savings. Some variable-rate offers are even falling around the 1% mark – wow!
But is it worth it to save money on your interest rate this way? That is, by opting for variable-rate private loans? Should you take out federal loans instead?
Acquiring A Variable-Rate Loan
Different banks approve loan applications—and offer interest rates— according to different criteria. These banks are basically investing in a “loan portfolio.” They might want to fill out their portfolio with safer loans in order to offer low interest rates. One bank’s criteria may see you as a low risk while another sees you as a more significant risk.
That’s why you should apply to a variety of different lenders – see who will give you the best interest rates and terms. Ultimately, though, realize that this is a major financial decision, and it should never be taken lightly.
Variable Private Loans – The Risks
Debt interest rates are either “fixed” or “variable.” If they are fixed, it means the interest rate stays the same forever (until the loan is totally repaid, that is). If the interest rate is variable, it might adjust over time depending on various market factors. Lenders may try to convince you that the variable interest rate is better by offering a low initial rate compared to the fixed option.
In general, private loans tend to pose a greater risk to the borrower than their federal cousins. That’s because the bank itself is taking a financial risk by lending money with no government guarantee of repayment from the government. That’s why private banks tend to run things a bit more tightly. Interest rates are based on your credit score, and there’s way less flexibility there.
But the biggest risk to someone who takes out a private loan is that the payments have to be made regardless of your financial situation. Some private lenders might give you a few months of forbearance, but there simply isn’t much that can be done if your private loans are overwhelming you.
Risks include taking out loans and failing to graduate, falling on hard times, or discovering that your income just isn’t what you had in mind when you took the loans out. IUt’s also possible that market interest rates could increase, making repayment more expensive overall. If your loans have a fixed interest rate, then when rates increase, you’re safe – those rates don’t change from the initial quote. If you have a variable rate, then in order to switch to a fixed-rate loan, you’d need to refinance.
The possibility of interest acceleration is called “interest rate risk,” and it’s a fairly big deal. It’s hard to know how rates will shift over time though, so it’s always possible that a variable-rate plan ends up costing you less. It’s all up to the market, which no one really controls.
Who Should Opt For A Variable-Rate Student Loan?
It’s hard to put a straight answer to this, but check out the lists below. You can use them as guidelines while assessing your own personal situation.
Don’t Take Out Variable Loans If:
- You might work for a qualifying PSLF (public service loan forgiveness) employer.
- Your total student debt will exceed expected annual income after graduation.
- The cost of going to school is already covered by Stafford Subsidized loans.
- You don’t qualify for a low interest rate with respect to private loans.
DO Consider Taking Out Variable Loans If:
- You’ll never work for a PSLF employer.
- Your annual salary will almost certainly exceed the debt when graduating.
- You qualify for a low variable rate, but you can afford a much higher rate if need-be.
- You’ve exhausted all other options, and there isn’t a less expensive option.
- You have peerless financial discipline, and you can comfortably live beneath your means after graduation until everything is paid off.