Fixed vs. variable student rate loans: Determining which is best for you
One of the critical considerations international students should review when selecting a student loan for study abroad in the U.S. or Canada is whether to choose a loan with a fixed or variable interest rate.
Here’s a review of the advantages and disadvantages of both types of student loan interest types.
Fixed-rate student loans
A fixed-rate student loan is an education loan with an interest rate that never changes, meaning your monthly loan payment will not fluctuate. An international student loan fixed rate will stay constant from the date you sign your loan agreement until your very last payment.
It’s an option to look into if you want a predictable payment structure.
Advantages of a fixed-rate loan
- Your borrowing cost is predetermined. Since your interest rate won’t change, you can calculate precisely how much interest you’ll pay throughout the life of the loan.
- Your payment amount is the same each month. With a fixed rate, there are no surprises when it comes to the payment amount that’s due. Your payment amount is generally divided into equal monthly installments for the length of your repayment term.
- Easier planning for your monthly budget. In addition to simplifying your repayment experience, fixed-rate student loans make budgeting easier. Since monthly payment amounts are predictable, planning around other financial goals and responsibilities is less challenging. You’ll know exactly how much is left over from your budget outside your loan payment.
Despite the straightforward benefits of an international student loan fixed rate, there are other considerations.
Disadvantages of a fixed-rate loan
- Your starting rates may be higher. Since lenders don’t have the opportunity to increase fixed rates later, starting fixed rates can be higher than variable rates.
- You won’t benefit from lower-rate markets. In periods when market rates are low, variable rates might drop. With a fixed rate, you’re charged at your original rate, even if it’s high by comparison. It’s less risky but means you may pay more during low interest environments.
Variable-rate student loans
A variable-rate student loan is an education loan with rates that can adjust over time. Variable interest rates are determined by two components: a benchmark and a spread. A variable benchmark is used to price macroeconomic risk, and a fixed spread is used to assess the risk of lending to an individual borrower.
Benchmark rates fluctuate based on local and global economic factors. Lenders usually peg the benchmark to an index, such as the Secured Overnight Financing Rate (SOFR).
SOFR is one of the most common indexes used for private student loans. Through this product, lenders pass interest rate risk onto borrowers, especially in increasing rate environments.
Some lenders enforce a rate cap, which is the maximum rate you can be charged, regardless of market conditions. Some lenders also enforce a rate floor, which is the minimum rate you can be charged, regardless of how low the underlying index falls.
Advantages of a variable-rate loan
- Your variable starting rate might be lower. The initial rate on a variable-rate student loan is typically lower compared to the starting rate on a fixed-rate loan. Although variable rates can change, for a time, you’ll at least have a window of lower interest charges.
- You may experience interest rate drops. If market rate conditions cause your interest rate to drop, that could lower your monthly loan payment temporarily.
Disadvantages of a variable-rate loan
- Your interest rate will fluctuate. Variable rates ebb and flow with the benchmark index that your lender follows.
- Your monthly payment amounts are uncertain. The interest rates can adjust periodically so it can be difficult to pin down exactly how much you’ll owe each month.
- You might find it harder to plan a monthly budget. The fluctuating nature of variable rates means you’ll always have to be financially prepared for a rate increase. This can make budgeting a bit more complicated.
- Projecting your total cost of borrowing might be difficult. Since you can’t predict exactly when your variable rate will change, calculating how much an education loan will cost you over time is challenging. Depending on the market a variable rate might be more affordable upfront, but more expensive in the long run.
Fixed vs. variable rates: which type of interest rate to choose
Ultimately, there’s no one-size-fits-all approach to choosing an interest rate that’s right for you. It depends on your repayment goals and how comfortable you are mentally and financially with financial changes.
A fixed interest rate, which MPOWER Financing offers, might make sense if you prefer a steady rate and monthly payment or if your income can’t withstand sudden payment increases. If your financial situation is secure and you can handle potentially higher monthly payments later, the benefit of a lower starting variable rate and payment might be worthwhile.
