Student loans: Variable or fixed-rate, which is better?

Whether you’re taking out a brand-new student loan or considering a private student loan refinance, one important decision you’ll need to make is which kind of rate to choose. Most lenders let you pick between two types of rates: fixed or variable. With a fixed-rate loan, your rate is locked in; the lender guarantees that your interest rate will stay exactly the same throughout the life of the loan. With a variable-rate loan, however, your the interest rate can go up or down based on market conditions.

So, variable or fixed-rate: which is better? There’s no easy answer. Both fixed- and variable-rate student loans have their pros and cons. When choosing between them, you should consider whether you expect national interest rates to rise or fall, and how that might affect your future monthly payments. You should also consider how long you expect to have your loan — and whether or not you want to gamble on changing rates. Here’s what you need to know about fixed- vs. variable rate loans, and how to decide which one may be right for you.

What is a fixed-rate student loan?

A fixed interest rate — sometimes called a fixed APR (Annual Percentage Rate) — is an interest rate that is one that never changes. When you borrow a fixed-rate loan, it means your minimum payment won’t rise or fall over the life of the loan. Instead, you lock in your terms when you sign the agreement. One reason borrowers, like fixed-rate loans is that they provide a kind of “interest rate insurance.” In other words, they may cost a little more upfront, but paying that premium protects you against price changes down the road.

Federal loans always come with fixed interest rates. These federal loan rates are set in the summer at the start of every school year and remain the same for all borrowers, regardless of credit history or financial situation. Private student loans, on the other hand, can be either fixed or variable.

Pros of a fixed-rate student loan

• There’s less risk involved. With a fixed-rate loan, the interest rate doesn’t change over the repayment term. That means you won’t need to worry about rate hikes or economic uncertainty.

• Your payment is the same every month: Choosing a fixed-rate loan means your monthly payment doesn’t change. Because it’s a consistent, predictable expense, it’s much easier to budget for.

• You know your exact loan cost Since your interest rate and amount due are the same every month, you can easily figure out how much you’ll owe on your loan in total. Simply multiply your monthly payment by the number of months you have left in the repayment period.

Cons of a fixed-rate student loan

• You may end up paying a higher interest rate: Fixed-rate loans typically  start off with higher interest rates than variable-rate loans do. So, at least in the beginning, you’ll likely pay more per month with a fixed rate than you would with a variable rate.

• You could miss out on interest rate savings: Unlike variable interest rates, fixed rates don’t change according to national interest rate trends. So, if you have a fixed interest rate and national rates drop, you won’t be able to reap the benefits. However, you’ll always have the option to refinance your student loans if you think you can score a lower rate.

• You may pay more over the life of your loan: Fixed-rate loans generally have higher rates than variable rate loans. And while they offer borrowers the potential for insulation against unexpected rate hikes, borrowers often end up paying more with a fixed-rate loan than they would with a variable-rate loan. That’s especially true if you have a short loan term, which gives rates less opportunity to sneak up on you.

What is a variable-rate student loan?

A variable interest rate is one that fluctuates according to national interest rate trends. In contrast to a fixed-rate loan, your payments on a variable-rate loan can get more expensive — or less expensive — as time goes on.

So, how does this work? Most variable rates are pinned to some kind of prominent national rate, called a reference rate. One of the most popular reference rates is the Secured Overnight Financing Rate (SOFR). This is a national benchmark that goes up or down depending on how the Federal Reserve behaves. It loosely indicates how much it costs to borrow money at any given time, and banks use it as a measuring stick to set their own rates.

When inflation increases — a condition that makes banking more expensive — lenders can increase your variable interest rates to cover their costs. This gives them an extra layer of security in case of a high interest-rate environment. This is why lenders are usually willing to offer variable-rate loans at a lower rate. Many lenders’ variable-rate loans start out lower than their fixed interest-rate loans. This can make variable rates tempting to borrowers. But it’s important to remember that it your rate will fluctuate over the life of the loan as the SOFR rate changes. This means your minimum payment could rise or fall, as well.

A final thing about variable rates to keep in mind: There is no limit to how much the reference rate can rise or fall in any one year, but  most loans do come with an interest-rate cap, often called the maximum Annual Percentage Rate (APR). Your lender guarantees that your interest rate will never surpass this cap.

Pros of a variable-rate student loan

• Your interest rate may be lower: Variable-rate loans generally have lower interest rates than fixed-rate loans, at least to start.

• You can take advantage of market changes: If market conditions become more favorable, your variable rates will automatically drop, leaving you with lower monthly payments and more money in your pocket.

• You could save money over the life of your loan**:** Lower rates mean you’ll potentially pay less in interest charges overall, which could save you money in the long run. This is particularly likely if you have a shorter loan term.

Cons of a variable-rate student loan

• Your interest rate could go up: Although variable student loan rates often start out lower, there’s no guarantee they’ll stay that way. You may find yourself paying a higher rate as market conditions change and rates rise.

• Your monthly payment might increase: Interest rates fluctuate with variable-rate loans. That means your monthly payment could go up if rates rise. Some private lenders have an interest rate cap based on the highest variable APR they’ll allow your loan to reach. Still, the new payment could be more than you can afford, throwing you a major personal finance curveball.

You can’t calculate how much you owe: Since your rate has the potential to change at any time, it’s impossible to know your total student loan repayment amount. If rates go up significantly, you could end up paying hundreds or thousands more in interest charges than you planned on.

Can I switch from variable to a fixed-rate loan?

It is possible to change your mind about the type of interest rate you want and switch it later. If you have loans with a private lender like Earnest, you’ll be able to switch at any time without incurring any fees. You’ll just need to have made at least four months of consecutive, on-time payments on your original loan. Just keep in mind that we will conduct a hard credit check before we can switch you. This can sometimes drop your credit score by a few points. Also remember that the APR on your new loan will be based on prevailing student loan interest rates and your financial profile at the time of your request, which means the new rate could be higher than what you were offered originally

Using refinancing to switch rate types

If your private lender doesn’t allow you to switch rate types, you can always switch your lender and rate through student loan refinancing. Refinancing involves finding a new lender to pay off your old loans for you. In exchange, they’ll issue you a brand-new loan with new terms. Most lenders let you choose what type of loan and rate you want during this process.

The other benefit of refinancing is that your new rate will be based on your current financial profile — which means that if you’ve improved your income or credit score since you last took out your loans, you could qualify for a dramatically lower rate. That can save you even more money over the life of your loan².

Keep in mind that you’ll need a good to excellent credit score to qualify for a private lender’s best loan options. If you don’t have a good credit score on your own, you may be able to secure a lower rate through the use of a cosigner.

How to switch from a fixed rate to a variable rate

If you have private loans, you can use student loan refinancing to switch them from fixed rates to variable rates without much fanfare. But if you have federal student loans, the process can require a little more consideration. Refinancing federal loans through a private lender gives you the opportunity to secure a lower interest rate and/or switch to a variable rate. However, this turns them into private loans, which means they’ll no longer be eligible for student loan forgiveness and other federal programs. This process cannot be reversed. So, while refinancing federal loans has the potential to save you up to thousands of dollars in interest, it’s worth some extra thought.

Variable loan or fixed-rate loan: Which should I choose?

Choosing between variable or fixed-rate student loans depends on your priorities, including how quickly you plan to pay off the loan, how well you can stomach the risks of a potential rate increase, and how the monthly payment amount fits your budget.

A variable-rate loan may be ideal for you if:

• You want lower monthly payments in the short term.

• You plan to pay off the loan quickly, in which case interest rates likely won’t have enough time to rise very much.

• You’re willing to take a little risk in exchange for potential savings. (You can estimate the exact savings with a student loan calculator like this one.)

A fixed-rate loan may be ideal for you if:

• You prefer a predictable monthly student loan payment.

• You want to lock in the interest rate for the long term.

• You plan to take a longer loan term to pay off your student loan debt.

• You have the credit score and financial standing to refinance when interest rates are lower.

• If you’re gung ho about a fixed-rate loan, there are a number of federal and private options available.  Direct PLUS Loan is another option to consider. These federal student loans come from the Department of Education and are often made to graduate or professional students or parents of dependent undergrad students to assist with costs not covered by other financial aid. The perks of a Direct PLUS loan are the government pays the interest charges while you’re in school. Like most federal student loans, the interest rates are fixed, which means there’s less likelihood of surprise rate increases than there might be with a variable APR loan.

Calculate much you could save with Earnest

Whether you choose a fixed or variable rate is a highly personal decision. A fixed-rate loan may be a good fit if you prefer predictable monthly payments and you think it may take you a while to pay off the loan. On the other hand, a variable-rate loan may be more appealing if you want to take advantage of low initial rates and intend to pay off the loan quickly. It all depends on your comfort level and what works best for your situation. And if you change your mind, you can always switch the type of rate you have through a student loan refinance.

Ready to refinance? Consider a low-cost refinance loan from Earnest. We never charge origination fees or prepayment penalties, and we let you skip a payment once per year for free³. To see what kind of rates you could qualify for, get a free rate check today. It takes minutes, it’s free, and it won’t affect your credit score.

This blog post provides personal finance educational information, and it is not intended to provide legal, financial, or tax advice.

¹ Please note that you may lose benefits associated with your underlying federal loans, such as federal Income-driven Repayment Plans (an example of which is the SAVE plan), Economic Hardship Deferment, Public Service Loan Forgiveness, or other deferment and forbearance options, if you refinance into a private loan. If you file for bankruptcy, you may still be required to pay back this loan.

² Choosing to refinance to a longer term may lower your monthly payment, but increase the amount of interest you may pay. Choosing to refinance to a shorter term may increase your monthly payment, but lower the amount of interest you may pay. Review your loan documentation for the total cost of your refinanced loan.

³ Earnest clients may skip a payment through a one, one-month forbearance during a 12 month period. Your first request to skip a pay can be made once you’ve made at least 6 months of consecutive on-time full principal and interest payments, and your loan is in good standing. The interest accrued during the skipped month will result in an increase in your remaining minimum payment. The final payoff date on your loan will be extended by the length of the skipped payment periods. Any unpaid accrued interest may capitalize (added to the principal balance) at the end of the forbearance period by adding unpaid accrued interest to the outstanding principal as permitted by law and the terms of the loan agreement.

For Student Loan Refinance Only:
Interest will not be capitalized on loans originated to Michigan residents under the Regulatory Loan Act of 1963. Please be aware that a skipped payment does count toward the forbearance limits. Please note that skipping a payment is not guaranteed and is at Earnest's discretion. Your monthly payment and total loan cost may increase as a result of postponing your payment and extending your term.