What Are Variable-Rate Student Loans?

You may be aware that mortgages can have adjustable interest rates, but so can student loans. Learn the details and the advantages and drawbacks of an variable-rate student loan.

What Are Variable-Rate Student Loans?
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Adjustable-rate loans, also known as variable rate loans, have interest rates that are tied to a benchmark index, such as the prime rate or the London Interbank Offered Rate (LIBOR). The interest rate on the loan can change periodically, typically every six or twelve months, based on changes in the benchmark index. Adjustable-rate loans became well-known thanks to the housing bubble and crash in the United States in the late-2000s, when adjustable-rate mortgages (ARMs) played a major role in mortgage default rates when the interest rates on these mortgages adjusted sharply upward after a few years of low rates.

Here, with this BrokeScholar article, we’re going to examine in detail how variable-rate student loans work, who provides these loans, and the risks and benefits of this form of borrowing, especially in comparison to getting a fixed-rate student loan.

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What Are Variable-Rate Student Loans?

When it comes to student loans, variable-rate student loans are less common than fixed rate student loans, which have a set interest rate that does not change over the life of the loan. However, some private lenders offer variable-rate student loans as an option for borrowers who want to take advantage of potentially lower interest rates.

It's important to note that adjustable-rate student loans can be riskier than fixed rate student loans because the interest rate can go up over time, potentially making the loan more expensive to repay. Borrowers who choose an variable-rate student loan should carefully consider the risks and benefits of the loan and be prepared to manage potential changes in their monthly payment amount.

Federal student loans, on the other hand, only offer fixed interest rates. The interest rate on federal student loans is set by Congress and is based on the type of loan and the academic year in which it was disbursed. The interest rate on federal student loans does not change over the life of the loan, making them a predictable and stable option for borrowers.

What Percentage of Total Student Loans Are Variable-Rate Loans?

Variable-rate student loans are less common than fixed rate student loans, and as such, they make up a relatively small percentage of total student loans in the United States. According to data from MeasureOne, a data analytics firm that specializes in student loans, in the first quarter of 2021, only about 6% of all private student loans originated were variable-rate loans.

It's critical to note that this data only pertains to private student loans, as federal student loans only offer fixed interest rates. Additionally, the percentage of variable-rate loans may vary depending on the lender and the market conditions at the time the loans were originated.

While variable-rate student loans can be a viable option for some borrowers, they are less common than fixed rate loans and may carry additional risks due to the potential for interest rate increases. Borrowers considering an adjustable-rate student loan should carefully evaluate the terms and conditions of the loan, including the interest rate structure and the potential impact of interest rate changes on their monthly payments.

Considering Fixed Rate Student Loans vs. Variable-Rate Student Loans

When considering whether to choose a fixed or variable-rate student loan, borrowers should carefully evaluate their financial situation and future plans. Fixed-rate loans provide stability and predictability in monthly payments, which can be important for borrowers on a tight budget or with limited income. However, fixed-rate loans may come with higher interest rates compared to variable-rate loans, especially in a low interest rate environment.

Variable-rate loans, on the other hand, can be a good option for borrowers who expect their income to increase over time, or who plan to repay the loan quickly. When interest rates are low, variable-rate loans may offer a lower initial interest rate, potentially resulting in lower monthly payments and lower overall costs.

Interest Rate Cap

One important factor to consider when evaluating variable-rate loans is the interest rate cap. Most variable-rate loans come with an interest rate cap, which limits the amount by which the interest rate can increase over the life of the loan. Borrowers should carefully review the terms of the loan to understand the interest rate cap and how it may affect their monthly payments.

Repayment Terms

Another important factor to consider when evaluating student loans is the repayment terms. Some lenders may offer flexible repayment terms, such as interest-only payments or deferred payments, which can be helpful for borrowers who are experiencing financial hardship. Other lenders may offer incentives for borrowers who make timely payments or who enroll in automatic payments.

It's also important to consider the lender's reputation and customer service when choosing a student loan provider. Borrowers should research the lender's track record and reviews and consider factors such as their responsiveness to customer inquiries and their willingness to work with borrowers who are experiencing financial difficulty.

Monitor Changes in Your Student Loan Interest Rate

Variable rate student loans can change at different intervals depending on the terms of the loan agreement. The frequency of rate changes is typically determined by the specific terms set by the lender and can vary from loan to loan. Here are some common scenarios:

  • Annual Rate Adjustment: In some cases, variable rate student loans may adjust annually. This means that the interest rate can change once every year, typically on a predetermined date. Lenders may use an index, such as the London Interbank Offered Rate (LIBOR) or the prime rate, as a benchmark to determine the new interest rate.
  • Quarterly Rate Adjustment: Other variable rate student loans may have quarterly adjustments. This means that the interest rate can change four times a year, generally aligned with the calendar quarters (e.g., January, April, July, and October).
  • Monthly Rate Adjustment: Some loans may have monthly rate adjustments, where the interest rate can change every month. This can make the loan more sensitive to fluctuations in the market interest rates.

You must carefully review the terms and conditions of the specific student loan you are considering or have already obtained to determine how often the variable interest rate may change. The loan agreement should outline the frequency of rate adjustments and provide details on how the new rate will be calculated based on the chosen index and any additional margin.

The Bottom Line on Variable-Rate Student Loans

Ultimately, the decision to choose a fixed or variable-rate student loan will depend on the borrower's individual financial situation and goals. Borrowers should carefully evaluate their options, compare loan terms and interest rates, and choose the loan that best fits their needs and budget.

It's also important to remember that student loan debt can have a significant impact on a borrower's financial future, and that managing student loan debt requires careful planning and financial discipline. Borrowers should consider ways to reduce their student loan debt, such as applying for scholarships or grants, working part-time while in school, or choosing a less expensive college or university.

Additionally, borrowers should take advantage of loan repayment programs and forgiveness options, such as income-driven repayment plans or Public Service Loan Forgiveness, if they are eligible. These programs can help borrowers manage their monthly payments and potentially reduce the total amount of student loan debt they owe. You can even qualify and obtain a grant to payoff student loan debt.

In the end, variable-rate student loans are a less common option for borrowers compared to fixed rate loans but may be a good option for borrowers who expect their income to increase or who plan to repay the loan quickly. Borrowers should carefully evaluate the terms and conditions of the loan, including the interest rate cap and repayment terms, and choose the loan that best fits their needs and budget. Managing student loan debt requires careful planning and financial discipline, and borrowers should consider ways to reduce their debt and take advantage of loan repayment and forgiveness programs if they are eligible.

Andrew DePietro

Author: Andrew DePietro

Senior Researcher, and Content Strategist

Andrew DePietro is a finance writer covering topics such as entrepreneurship, investing, real estate and college for BrokeScholar, Forbes, CreditKarma, and more.