What Is Student Loan Refinancing
Student loan refinancing is when you take your loan and go to a private lender to change the terms of your loan and/or lower your interest rate. Effectively, you will borrow the same amount you owe with the new loan offering potentially more favorable terms, such a lower interest rate or lower monthly payments due to a longer repayment period.
You may opt for student loan refinancing for a variety of reasons. You may simply want to save money. With the given rates by the government at the time of your schooling, you may find that the market is offering more favorable rates now that will translate into quite a bit of savings over the life of your loan.
If you find your struggling to make your student loans payments and want to act while your credit is still good, a student loan refinance might be just the solution. Changing the repayment terms by lengthening the life of the loan could lower your payments and make them more manageable preserving your credit score and the credit youve worked hard to build up to this point.
To be clear, the federal government is not a private lender and will not refinance your federal student loans. Going this route will move your loans from the protections and benefits offered by the Department of Education and move them to a private lender, making them now private student loans.
When You Might Not Want A Variable
Although a variable rate might be appealing in some cases, here are a few drawbacks to think about:
- Interest rate could change: A variable rate can rise or fall along with market conditions. This could make it difficult to estimate your overall repayment cost.
- Unpredictable payments: Any changes in your variable rate will also mean shifts in your monthly payments.
- Potentially more expensive overall: Depending on how quickly you pay off your student loan, you might find yourself paying much more over time with a variable rate compared to a fixed rate.
Example Of A Fixed Vs Variable Interest Rate
When you applied for your loan, you were presented with a fixed interest rate option of 7.00% and a variable interest rate option of 5.00% .
The table below shows how the interest rate options would be affected in three different scenarios. Notice the fixed interest rate remains the same in all of the scenarios, and the variable interest rate goes up or down based on the changes in the index.
At the time of , a fixed interest rate will typically be higher than the starting variable interest rate. While the variable interest rate is cheaper to start, you should consider your personal tolerance for the risk that it could go up .
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How To Calculate Student Loan Interest
Before you commit to a student loan interest rate type and sign on a dotted line, calculate how much the loan and interest will cost you over its repayment period. Even if youre not a math person, you can calculate your student loan interest in three easy steps.
Lets say you borrow $15,000 with a 4% annual interest rate, which youll pay back over a 10-year standard repayment plan. In this case, your monthly payment would be about $152.
1. Divide your annual student loan interest rate by the number of days in the year to calculate your daily interest rate.
.04/365 = 0.00011, or 0.011%
2. Multiply your remaining loan balance by your daily interest rate to understand how much interest your loan gains each day.
$15,000 x 0.00011 = $1.65
3. Multiply your daily interest amount by the number of days since your last payment to calculate your monthly interest payment.
$1.65 x 30 = $49.50
Understanding Fixed Vs Variable
When deciding between a fixed versus a variable-rate loan, its imperative to understand how each of these loans works and what the difference between them is.
If you opt for a fixed-rate loan, the interest rate stays the same for the entire life of the loan. Youll know exactly how much interest youll pay each month, and in total, before you receive the loan funds and before you begin paying the loan back. Since the interest rate never changes, your monthly payments also never change.
With a variable-rate loan, on the other hand, your interest rate is not fixed for the life of the loan. It may be fixed for a set period of time. For example, if you took out a variable rate or adjustable rate mortgage, the loan rate might be fixed for the first two years, or five years, or even longer. After that period of time when the fixed rate expires, your loans interest rate can adjust.
The specific amount of time your initial interest rate is locked in will vary depending upon the kind of loan. In some cases, your rate is only fixed for a very short time. The frequency at which your rate can adjust is also determined by the lender and type of loan. Your rate may be restricted to adjusting just once per year, or it may adjust monthly or bi-annually.
Because your interest rate is able to change with a variable-rate loan, your monthly payments could change too. This means you could end up paying a higher — or lower — monthly payment than you started with.
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Comparing Fixed And Variable Interest Rates
Generally, a fixed interest rate will be higher than the correspondingvariable interest rate in a rising interest rateenvironment. Borrowers sometimes get confused about the difference inthe current interest rates, picking the variable-rate loan because thecurrent interest rate is lower. In effect, they treat the variableinterest rate as though it were a fixed interest rate. But, lendersprice fixed and variable-rate loans to yield the same income to thelender, based on models that predict a range of future changes ininterest rates.
Assuming a rising interest rate environment, a fixed interest rate ona new loan with a 10-year repayment term will generally be 3 or 4percentage points higher than the current variable interest rate.
There are two scenarios in which a variable interest rate is better than a fixed interest rate.
Fixed Vs Variable Rates At A Glance
|How it works||Pay the same rate over the life of your loan||Pay a rate that changes over the life of your loan based on the lending market, usually every one or three months|
|Monthly repayments||Changes depending on your current interest rate|
|Can I predict my loans total cost?||Yes|
|How does it compare to federal rates?||Usually higher||It can be lower if you have excellent credit and federal interest rates are low|
|Best for||Predictable monthly repayments with minimal risk||Finding extra-low rates when the economy is in a downswing and youre opting for a shorter term|
When You Should Choose A Loan With A Variable Interest Rate
If you have a variable interest loan, you will pay less interest at the point in time you take the loan. During the loan duration, youll either pay more, the same or less in interest depending on how the market develops.
The important lesson here is not to try to guess which direction the interest rates will go, because nobody knows.
You should choose a loan with a variable interest rate if you dont mind the risk. You should choose a loan with a variable interest rate if you:
- Have a high income
- Have a high net worth
- Have a high job security
- Have a stable life situation
- Have a high degree of certainty regarding your income in the future
- Have good insurances against other shocks to your finances
The good thing about a loan with a variable interest rate is that you will not pay a premium for your loan. The fixed interest rate loans act as an insurance towards future interest rate increases, and because the banks provide that insurance, they will usually charge more for this by charging higher interest rates.
Of course, this does not hold in all cases, but if you want to save on that insurance, I believe you should choose a loan with a variable interest rate if you can check off most of the above criteria.
Are Variable Rate Student Loans Right For You
So should you choose a fixed rate or variable rate student loan when you get a new or refinanced student loan?
First, you should do the math to see what youd actually be saving on interest. Use one of our student loan calculators to estimate your monthly payments and compare interest rates on multiple loan offers.
Besides doing the math, ask yourself how comfortable you are with the risk of a rate increase, along with how many years you expect it will take you to pay off your debt.
Variable rate student loans arent for everybody, but they can be a big money-saver for some. Depending on your circumstances, variable rate student loans could help you save on interest, lower your monthly payments and even pay off your education debt ahead of schedule.
Rebecca Safier contributed to the reporting of this article.
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Even Near 1% Are Variable Rate Student Loans Worth The Risk
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Federal student loan interest rates hit record lows on July 1. But those rates are still higher than what some private lenders are offering.
Multiple lenders, including Sallie Mae, SoFi and Citizens Bank, now advertise minimum variable loan interest rates below 1.5%. At this time last year, the average minimum variable rate for private student loans was 4.89%, according to NerdWallet data.
Rates for online lender College Ave start at 1.24%. The companys CEO, Joe DePaulo, says its their lowest rate ever and that more College Ave borrowers are opting for variable rates this year.
But variable rates change, and that risk isnt for everyone even for a rate near 1%. Heres how to tell if its right for you.
Fixed Vs Variable Interest Rates
When you apply for a private student loan, you may have the choice of selecting either a fixed or variable interest rate.
A fixed interest rate will remain the same throughout the life of the loan. It gives you the protection of knowing how much you will pay each month, but could mean you pay more over the life of your loan because fixed interest rates tend to start higher than variable interest rates. If you want predictable monthly payments and stability, a fixed interest rate may be the best option for you.
In contrast, a variable rate is an interest rate that may change periodically throughout the life of the loan. Variable interest rates are tied to an index. If the index changes, your loans interest rate will fluctuate with the corresponding index.
The interest rate chart is for illustrative purposes only and does not reflect specific past or future performance.
Increases in the interest rate on a variable rate loan could impact your budget. If your interest rate increases, your monthly payments will increase, and that can be challenging when you are balancing your monthly budget.
Did You Know?
If you choose a variable interest rate loan, your rate will not be exactly the same as the rate index.
Thats because variable rates are made up of two components: the index rate and an additional rate or range of rates that lenders add based on several lending criteria.
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Federal Student Loan Interest Rates
All federal student loans have fixed rates that will stay the same throughout the life of the loan. Federal rates are set by Congress and are updated each year. The rate you get on a federal student loan will depend on the type of loan you choose as well as your year in school.
Additionally, most federal student loans dont require a cosigner or a credit check.
Here are the rates you can expect for the 2021-22 academic year as well as how rates have changed over time:
- Direct Subsidized Loans: 3.73%
- Direct Unsubsidized Loans : 3.73%
- Direct Unsubsidized Loans : 5.28%
- Direct PLUS Loans : 6.28%
Learn More: Federal vs. Private Student Loans: 5 Differences
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When To Choose A Fixed
In some cases, a fixed-rate student loan could be the right option for your finances. Here are a few reasons why you might choose a fixed interest rate:
- Predictable monthly payment: With a fixed interest rate, your monthly payment will stay the same throughout the life of the loan.
- Fixed repayment cost: Because a fixed interest rate wont ever change, youll know exactly how much the loan will cost you.
- Could be less expensive for longer repayment periods: If you expect to repay your loan over several years, a fixed interest rate will likely be less expensive than a variable interest rate that could fluctuate over time.
Are Variable Rate Student Loans The Best Option For You
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When To Choose A Variable
There are also some situations where a variable-rate student loan might be the best choice for your needs. Here are a few benefits of variable rates to consider:
- Lower initial interest rate: Variable rates generally start off lower than fixed interest rates, which could be especially helpful if you plan to pay off your loan quickly before the rate can change too much.
- Lower initial payments: Because variable rates are usually lower than fixed rates to start, your initial payments will start off lower in comparison. This might be appealing if you expect your income to rise over time.
- Potential for interest rate drops: Depending on market conditions, a variable rate might drop in the future. This also means your monthly payments will be reduced.
Getting The Best Rates
Refinancing a student loan at the lowest possible interest rate is one of the best ways to reduce the amount of interest youll pay over the life of the loan.
You may find that variable-rate loans start lower than fixed-rate loans. But because theyre variable, they have the potential to rise in the future.
Fortunately, you can reduce your risk by paying off your new refinance loan quickly, or at least as quickly as possible. Start by picking a short loan term but with a manageable payment. Then, pay extra whenever you can. This can hedge your risk against potential rate increases.
Regardless of whether you decide on a fixed- or variable-rate loan, its important to compare rates across multiple lenders to make sure youre not missing out on possible savings. Theres a chance you could qualify for interest rate discounts by opting for automatic payments or by having an existing relationship with a lender.
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