One of the most common– and most important – student loan decisions is whether the student in question should favor a fixed or variable student loan. This very first, initial decision has an immense impact on your student life, as it changes how your loan interest will be calculated as you move forward. Obviously, this is not a light decision to make on a Sunday morning, and one should weight carefully all their options before comitting to a single loan type.
In short, a fixed student loan means that your interest rate will remain the same during the whole loan's period – it is a fully predictable way to know exactly what you are going to be paying per month, until you are no longer in debt.
On the other hand, a variable student loan will have the interest rate changed at many points during the student loan's lifetime, going up or down as necessited by variance in factors directly linked to the loan.
Fixed vs Variable Student Loan
An immediately evident upside of fixed student loans is that you can safely plan ahead with them. You can calculate your expenses accurately and surely, and thus you are able to invest your budget without having to worry of unpredictable raises in your debt. The volatile nature of a variable student loan, on the other hand, makes keeping a safety valve obligatory: You will likely have to save an amount of your earnings, in case something goes wrong, lest you want to limit your long-term planning capacity.
Unfortunately, it is not as easy or clear cut as that. The vast majority of variable student loans offer a much lower rate at the outset, which, depending on the ups and downs their interests may experience, result in a much lower overall repayment amount. Luckily, most variable student loans are usually capped at a certain interest rate – they cannot go any higher than that. Usually, however, their cap is often high.
In order to find which of the two types best suits you, it is necessary to weigh your options on two different scales. First, the mathematical scale: How much will each cost – or how much can it end up costing, in case of a variable loan? You know your own budgets, and you can make an estimate how far your wallet can allow you to spread.
The second, but no less important scale, is psychological in nature. Not everyone is as comfortable with risk as the next. You have to weigh in what is most important to you: The opportunity to win big time, taking a calculated risk to save thousands, or having the ability to rest at night easily, without dreaming monstrously shaped $$$ figures haunting you. This depends entirely on your own psychological make-up and tolerance to stress.
How to evaluate a student loan
In order to make the best decision for YOU, you need to evaluate a student loan based on the four, following questions:
- Loan Length: This is a practical question. Naturally, the longer the length of a student loan the more likely it is to be impacted by changing interest rates. Obviously, a loan that is stretched out for many years is less suitable for a variable interest rate, as there is much more unpredictability inolved. Depending on how long it will take you to pay your debt, you should be influenced towards the respective direction. A general rule of thumb goes as follows: The shorter the loan, the more suitable a variable interest rate is. The longer, the wiser it is to risk erring on the side of caution.
- Interest Rate Environment: Most private student loan lenders use the London Interbank Offered Rate (LIBOR). You would do well to research the interest rate environment thoroughly, as it is extremely relevant to your decision. Whether interest rates trends rise, remain stable or are beginning to drop is a huge factor. You cannot, unfortunately, predict with absolute accuracy what the future will bring, but you can understand its current course.
- Your budget: In general, you should only commit to a loan you could keep paying over the long term – as failing to do so will lead to all sorts of compications. While a variable rate might save you money at first, over the long run, chances are it will go up at some point or another. You should have a backup plan to deal with the worst, if it comes to pass.
- Risk comfort: Perhaps the most important factor to consider, is how important predictability is to you. If you are prone to stress, and like to have absolute control of your expenses and debt, then going for a fixed student loan is probably your best bet. In reverse, if you can handle a little instability in your life and are comfortable with the idea of perhaps having to spend more than you initially thought, you should definitely go with a variable student loan as they have a very real potential to save you lots of money.
At the end of the day, whether a fixed or variable student loan is right for you is a question you can only answer yourself. If you are not planning to pay off your loan fast, as the loan stretches over a long period of time, or if your future income level is uncertain, disabling you from having safety valves, then you should probably settle for a fixed rate loan.
If, on the other hand, you have the required budget to handle things potentially going the wrong direction, and you are comfortable with the inherent risk and unpredictability of variable rate student loans, your best bet is trying to win big and go for a variable loan. This way, in case the interest rate remains stable or drops, you will have saved thousands. And if it ends up rising, you have your back covered with your monetary safety valves.