Choosing Between Fixed and Variable-Rate Student Loans

As students and parents are reviewing their college bills, they may be considering a private education loan to close the gap between college costs and available financial aid. Private loan terms vary from lender to lender, sometimes widely, so it’s important for borrowers to consider their loan choices carefully. Which lender? What sort of repayment plan? And, one of the most vexing choices for some borrowers – do I want a fixed or variable rate loan? How does a borrower choose?

The New York Higher Education Services Corporation (HESC) advises students and families to consider all their options carefully, before securing a private loan and only after exhausting all available federal, state and institutional aid.

With a variable rate loan, the interest rate can fluctuate as often as every 3 months over the life of the loan. As a result, loan payments will vary as market interest rates vary – rising when market rates rise and declining when rates decline. If rates fluctuate materially, the effect on a borrower’s household budget can be substantial.

With a fixed rate loan, the interest rate never changes. As a result, loan payments remain stable and predictable for the life of the loan. Rising rates will not cause a strain on a borrower’s household budget.

Choosing between fixed and variable interest rates can be difficult. Often the initial interest rate on a variable-rate loan is more attractive than that of a fixed-rate loan with a similar term. But because the interest rate on a variable rate loan can change, comparing initial interest rates is not enough. Borrowers should take a longer-term view, considering how market interest rates tend to rise and fall in cycles.

For example, between 1990 and 2010 the Prime Rate fluctuated between a high of 10% (1990) and a low of 3.25% (now). Between 1970 and 1990, the fluctuation was far greater, ranging from a low of 4.75% (1972) to a high of 21.5% (1980).*

HESC suggests three factors that borrowers should consider before taking a private loan:

Before making a choice, borrowers should think about whether or not they would be comfortable with such fluctuations in interest rates and the resulting changes in their loan payments? With the possibility of such rate swings, many borrowers would prefer the security and predictability of fixed loan payments.
Borrowers should also consider the term of the loan. The longer the term on a variable rate loan the longer the time period the borrower has to be ready to accommodate fluctuations in interest rates and the accompanying changes to the family budget.
Finally, borrowers should consider timing. We are currently enjoying a period of unprecedented low interest rates. Although no one knows whether, when, or how much interest rates will change, common sense seems to indicate that rates will increase in the near term. When borrowers choose between variable and fixed rate loans, they must remember to factor this into their decisions.

Borrowers who are taking a private loan to fill a college funding gap should consider more than just today’s interest rates and which lender to choose. They must decide between fixed or variable rate loans and choose the loan that’s right for them.

Scholarship sources say that students and families who neglect loans offered by their home states could be missing out on some of the best college financing options. Specially priced state financing programs generally offer students a reliable source to more affordable private education loans.

Currently, New York’s state-sponsored loan program, NYHELPs, offers fixed rate interest rates ranging from 7.55 percent to 8.75 percent, depending on the repayment option selected.

About NYHELPs: NYHELPs is a state-sponsored loan program administered by the state agency that helps people pay for college, The New York State Higher Education Services Corporation (HESC). HESC administers the Tuition Assistance Program (TAP) and numerous other grants and scholarships.

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* Source for interest rate figures: US Federal Reserve Board: Daily bank prime loan interest rates. Figures are annualized using a 360-day year or bank interest. Rate posted by a majority of top 25 (by assets in domestic offices) insured U.S.-chartered commercial banks. Prime is one of several base rates used by banks to price short-term business loans.