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Variable Interest Rate Student Loans – Home / Paying for College / Financial Aid / International Student Loans Variable or Fixed Rate – What Should I Choose?
If you are looking for international student loans to study in the United States, your first consideration is whether to get a fixed or variable rate student loan. But there is a lot of confusion about the difference between these two types of student loans and what it means in terms of future payments and financial risk.
Variable Interest Rate Student Loans
The good news is we’ve got you covered – read on for everything you need to know!
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Fixed rate loans are exactly what they say – fixed, meaning your rate never increases! For example, a certain interest rate will be quoted simply as “12%” or “10.5%”.
Variable interest rates, also known as floating or adjustable interest rates, change based on market fluctuations. They are determined by two components:
The standard benchmark for variable student loan rates used to be LIBOR or, to give it its full name, the London Interbank Offered Rate. It has now been largely replaced, at least in the United States, by the SOFR (secured overnight financing rate).
A variable interest rate is quoted with a benchmark and spread, for example, “SOFR + 8%.” The loan agreement will also specify how often your rate will be adjusted (for example, every month or every quarter, depending on changes in the underlying benchmark rate).
Student Loan Interest Rates Faqs
The short answer is that it depends on your tolerance for risk. The initial interest rates for variable rate student loans are generally lower than fixed rates, but if and when market rates rise, the interest rates on these loans may be higher than fixed interest rates.
That said, there is one big advantage to variable rate student loans: If market rates remain low, you may pay less for a variable rate loan than a fixed rate loan.
Of course, if the benchmark goes up high enough, you’ll have to pay significantly more. And if you’re lucky and it goes down, you’ll have to pay even less than the initial rate.
No one can say for sure whether SOFR or other benchmark rates will increase. However, Kiplinger’s interest rate forecast states that “…expectations for the future path of interest rates…show a gradually rising trend over the next two to three years.” Historically, LIBOR rates have been very volatile, peaking at around 11% in 1989.
Fixed Vs. Variable Student Loan Rates
Let’s say you borrowed $30,000, and you repay the student loan principal and interest over a 10-year term, with payments to be made monthly at a 12% fixed interest rate.
Using a student loan repayment calculator or a simple Excel formula, you can calculate that your monthly payment will be $430.31 (assuming interest is calculated on a monthly basis, not a daily basis). You will have to pay the same amount every month for ten years. The only thing that will change is the relative proportion of each payment that is to interest or principal. At the beginning of your loan, a large portion of the payment goes towards interest and in later periods, a large portion of this payment goes towards paying off the principal.
For example, in the first month, you still owe $30,000, so the interest payment would be $300. You calculate it by multiplying the outstanding balance by the annual interest rate divided by the number of payment periods in a year. Therefore, since payments are made monthly and there are 12 months in the year, the monthly interest paid in the first month is $30,000 x (.12/12) = $300. The difference between your $430.31 payment and the $300 interest fee is $130.31, so your principal balance is reduced by $130.31.
The next month, you calculate interest based on the new principal amount of $29,869.59. While payments remain constant at $430.31, only $298.70 is now accounted for in interest, so the principal amount paid increases to $131.72.
Why Are Student Loan Interest Rates So High Right Now?
Assuming you make payments on time, don’t pay the loan off early, and don’t get a discount on the lender’s interest rate, you’ll pay a total of $51,649.54 over the course of the loan—and that won’t change no matter what the market. Conditions of!
Let’s take the same $30,000, 10-year student loan from the fixed rate example, but let’s say it’s a variable rate loan with an interest rate of “SOFR + 8%.”
This means you have to pay 10% interest initially (because 2% + 8% = 10%). The lender calculates the monthly payments as if the rate will remain constant (even though it won’t!), so the initial monthly payment will be $396.45 (assuming interest is calculated monthly, not daily). So for that first month, you’ll save about $34 over the amount you would have paid to borrow the same amount with a 12% fixed-rate loan (see fixed-rate example above).
However, if the SOFR increases to 4%, your interest rate will increase to 12% (because 4% + 8% = 12%). You are now paying the same interest rate as you would in the fixed rate example above. The lender will then recalculate your monthly payment based on three factors: (a) the new interest rate of 12%, (b) the number of months left on your loan, and (c) the amount of principal you still owe.
How Do Student Loan Interest Rates Work?
If the SOFR increases to 8%, your interest rate will increase to 16% (because 8% + 8% = 16%). Let’s say this happens at the end of Year 4, so you have 72 months left on your loan. Let’s say you have a principal balance of $22,106.17. (This is the principal amount that would be outstanding if interest rates increased consistently by 1.5% per year over these four years and the rate was adjusted only at the beginning of each year.) Your new monthly payment would be $479.52, about $50.
On the other hand, let’s say SOFR rates drop to 1% at the end of Year 1, so you have 108 months left on your loan and the principal balance is $28,159.74. (This is the principal that will be outstanding after 12 months of payments of $396.45 with a 10% interest rate, as explained at the beginning of this section.) Your new interest rate will be 9% and your monthly payment will then be reduced to $381.36…and stay there until rates go up again.
The bottom line is that only you know if your payout will suddenly increase in exchange for a lower initial rate if you’re willing to take the risk.
Fixed rate loans mean that the interest rate on your loan does not change over time. Variable-rate loans are where your loan’s interest rate can change over time (based on an “index”)
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Variable interest rates may start out at a lower rate than a fixed interest rate, but depending on market conditions, the variable interest rate can increase over time and even increase your monthly repayments. It is important to understand the difference between variable interest rates and fixed interest rates if you are considering a loan. Whether you’re applying for a new mortgage, refinancing your current mortgage, or applying for a personal loan or credit card, understanding the difference between variable and fixed interest rates can help you save money and improve your finances. Can help in achieving goals.
A variable interest rate loan is a loan in which the interest rate charged on the outstanding balance changes with changes in market interest rates. The interest charged on a variable interest rate loan is tied to an underlying benchmark or index, such as the federal funds rate.
As a result, your payments will also vary (as long as your payments are blended with principal and interest). You can find variable interest rates in mortgages, credit cards, personal loans, derivatives, and corporate bonds.
Fixed interest rate loans are loans in which the interest rate charged on the loan will remain constant for the entire term of the loan, regardless of market interest rates. As a result your payment will remain the same throughout the term. Whether a fixed-rate loan is better for you will depend on the interest rate environment at the time you take out the loan and the length of the loan.
Why Are Student Loan Interest Rates So High?
When a loan is fixed for its entire term, it remains at the then-prevailing market interest rate, plus or minus a spread that is unique to the borrower. Generally speaking, if interest rates are relatively low but about to rise, it is better to lock your loan in at that fixed rate.
Depending on the terms of your contract, your interest rate on the new loan will remain the same, even if interest rates reach higher levels. On the other hand, if interest rates are falling, it may be better to take a variable rate loan. As interest rates fall, so will the interest rate on your loan.
This discussion is simplified, but the explanation will not change in a more complex situation. Studies have found that over time, the borrower will pay less interest overall on a variable rate loan than on a fixed rate loan.
However, historical trends are not necessarily indicative of future performance. The borrower should also consider the amortization period of the loan. The longer the amortization period of a loan, the greater the impact of the change
