All too often, when students and parents are searching for the best deal for their student loans, they focus on finding the lowest rate, but forget to consider the rate type. Later, when they are in repayment, they are often shocked when their monthly payments change. This is why it is critical that you don't only look at your student loan interest rate, but also pay attention to the type of rate that you are being offered.
There are two main interest rate types: fixed and variable. At first glance, it isn't always clearly designated on a lender's website which rate type is being offered, so you may have to do some digging. Here are the important differences in rate type and why you should always be aware of what you are choosing before you sign your promissory note.
- As the name suggests, your rate is fixed, which means it doesn't change.
- Over the repayment term, your payments will remain the same (unless you get a late fee tagged on, become delinquent, or default).
- Fixed rates are often a little bit higher than variable rates when comparing, but they have less risk associated with them.
- The rate you receive may be based on your credit or the type of repayment term you choose. You'll need to ask different lenders when comparing to determine if WYSIWYG (what you see is what you get).
- Your rate changes as market conditions change.
- Your rate will usually be set based on an index such as Prime Rate or LIBOR.
- There is usually a mark up on the index, often set based on your credit score.
- For example, if you have a "fair" credit score, you may be offered a variable rate of Prime + 5%, but if you have an "excellent" credit score, you may be offered a variable rate of Prime + 1% (these are just examples and are not referring to any specific lenders rates) - keep in mind, these are just examples, not RISLA rates.
- As the index changes, so does your monthly payment.
- Naturally, because your monthly payment changes, there is more risk associated with a variable rate loan.
If you can get a much lower rate on a variable rate loan than a fixed rate loan, it may be worth considering, but you must make sure you have wiggle room in your budget to support a higher payment if rates changes drastically.
For example, if you have a $30,000 loan balance, and your variable rate is set to 5%, your monthly payment over 15 years is about $238. If the rate is set to 9%, your payment for 15 years would be more like $305.
Rates are unlikely to jump 4% at once, so your monthly payment changes would most likely be incremental on a variable rate loan, but if 10 years from now rates are much higher, you may be wishing you opted for a fixed rate option.
At RISLA, we do offer a variable rate option, but encourage borrowers to take advantage of the fixed rate loan when possible. If you are a lucky resident of RI, or you will be attending (or already attend) a college in RI, you will have access to this great low rate option.