When you borrow money to pay for college, in many cases, you’ll be charged a fee to borrow it. In this article, we’ll discuss the two most common fees charged, when you are charged, and why to choose one fee over the other.
What are interest rates?
Whenever you borrow money via a lender, you will generally have to pay a fee to borrow that money. This fee is charged whether it is a credit card or a loan with a set time limit for repayment. This fee is called an interest rate, which is a percent of the money charged on an annual basis to borrow the money. For instance, an interest rate of 2 percent is charged annually to borrow $2,000. If you didn’t make a payment for a year and there weren’t any late fees charged, you’d accrue $40 in interest. If you made payments, the amount of interest you would get charged would go down each month because you are borrowing less money as you pay the loan down.
What is a variable interest rate?
A variable interest rate is one that can change based on the terms of the loan. For instance, a rate that varies may be 3 percent early in the year and 4 percent later on in the same year. The main reason for this fluctuation with a variable interest rate is due to a change in the general economy. For instance, when mortgage rates increase, the rate for a variable rate student loan will increase, as well. In any instance where a loan has not been “locked in” at a set rate, a variable rate will go up or down over time to reflect changes in the economy. Federal student loans aren’t issued with variable rates, however, private student loans may or may not be issued with variable rates.
Fixed rate student loans keep the same interest rate for the entire length of the loan. For instance, a loan issued with a rate of 3.5 percent that is fixed would always have the same interest rate, even years later.
Pros and cons of variable vs. fixed interest rates
One of the benefits of a fixed interest rate is that you will always have the same payment. Generally, fixed interest rates are the preferred student loan borrowing method for most people. The only time you would want to choose a variable interest rate is if the rate is lower and you’re planning on paying off the loan in a year or less. In that case, you don’t have to worry too much about interest rate increases.
What is the current interest rate environment?
Interest rates are rising and expected to rise higher in 2017. The reason behind this rise is because rates have been so low for so long. This increase won’t mean anything for current borrowers with fixed interest rates, but borrowers with variable rates may want to pay off loans earlier if they can. The good news is that rates will rise slowly. New borrowers in this environment will likely want to borrow fixed rate loans, especially if they are borrowing for more than one year.
Jon is a writer and marketer for Nitro who is passionate about bringing transparency to the student loan process along with providing families with the information needed to make smart financial decisions. He also just recently refinanced his student loans allowing him to pay them off 5 years faster all while saving an additional $152/month. As he continues to pay them off himself, he strives to help others do the same. Jon also has a long history of connecting people with educational opportunities to help them improve their careers and their overall personal finances. In his free time you can find him reading travel blogs and researching destinations around the world in search of his next adventure. Read more by Jon O'Donnell