I didn’t come into the start of the creating of this post with a strong feeling one way or the other concerning private student loan refinancing options and whether I would be leaning towards recommending going with a fixed rate loan or going with a variable rate loan to my Camelitos on Loan Camel. To a major extent, it’s really personal preference, especially now that the rates are so low.
In some ways, the decision to me really depends on the circumstances, particularly how long the length of the loan you are considering taking out to do your refinancing will be. I know some experts recommend based strictly on the length of the loan you are taking out with defined cutoffs from when they would recommend going to a fixed rate over a variable rate. They are afraid of the unpredictability of the market beyond the first few years.
I don’t follow that train of thought. In fact, I don’t think that’s putting much thought into the matter and really placing yourself in the shoes of the individual borrower. Not with rates this low and refinancing free, easy and available.
Like we’re all one and the same – one homogeneous loan without any of our own feelings, issues, needs – whatever it is – that may slightly distinguish us from each other. To me that just feels like a safe rule of thumb, one size fits all solution and Daddy Poorbucks ain’t doing that “here’s a rule follow it – all of you” type of thing. F that. You deserve a thoughtful effort in consideration for your readership.
But all of that Camel machismo and bravado aside, the fixed rate loan is a fine choice for me because it’s free to refinance if rates really drop and if they rise – well, you’re protected. and I am not addressing federal loans because you can refinance them the same way but there are other perks available in a federal loan program which you can forfeit if you refinance with a private lender and that takes a different type of consideration before pulling the trigger.
So with that said, let’s get to it.
Glad you asked. OK, it was my question and you probably already know the answers but here it goes:
As you would figure, a fixed rate loan maintains the same (“fixed”) rate for the entire life of the loan so that all monthly payments are locked in and equal. You know what you are getting today and it will be the same payment you would make today as you would in 19 years & 11 months from now if you go out that long. Speaking of which, the longer the term of the loan, the lower the monthly payment will be. Often, shorter term loans have the lower interest rates as there is less risk with less time to repay the loan.
A variable rate loan payment changes based on the market indicator that it is tied to, which in the case of variable loans is often the monthly adjusted London Inter-Bank Offered Rate, more recognizably known as LIBOR. So with a variable rate loan, you are starting out with a lower rate than whatever the fixed rate is but you are not locked in to that rate. There is rate hike risk with increase and the reward of a lower rate with decrease. It is often offered with a cap which is a rate that it cannot exceed. That cap is much higher than the fixed rate you would have gotten from the same lender at the time of signing.
So this is where you can see why some would tell you to go with a fixed rate loan if you are borrowing with a term greater than a few years. Lock in a good rate now and never worry about it increasing. I’m not opposed to that thought process if it suits your personality and, for me, I would likely do it too. But then again I’m a neurotic Jewish mess who grew up in fear of whatever was potentially in the closet or under my bed… so there’s that too.
Hey there goes a squirrel. Anyhow, if the break even point for choosing a fixed loan is at 3 years, it would probably take more than double that time with increases to a variable rate loan to average the fixed rate that you could have chosen… maybe longer. On top of it, with the ability to refinance for free, you can always start at one rate structure or the other and then refinance, for instance, from variable to fixed if you see rates going up, or, from fixed to another fixed (or variable) if you see rates headed down.
To some degree, it doesn’t matter that much in the case of a variable loan as long as you pay attention and keep term length somewhat in mind. But if you don’t want to think about it and want a set payment then fixed is a good option for you like it would be for me. I would definitely pay attention to the rates over time with a fixed interest rate loan because if the rates decrease a good amount, while your credit is improving, you can refinance again at a better fixed rate. All that said, often there isn’t much savings so going with a fixed rate loan makes a lot of sense to me regardless.
Like the rap group Black Sheep said back in the early 90’s – The choice is yours. And to help with the choices, let’s take a look at the differences in monthly payment between a fixed interest rate loan and a variable interest rate loan on a ReFi. I mean for real, enough of my gibberish – let’s see what the numbers look like when looking at private student loan refinance options.
Loan Amount: $50,000.00
Loan Term: 10 Years (120 Months)
Interest Rate: 3.46% (Fixed/Excellent Credit)
Monthly Payment: $493.00
Loan Amount: $50,000.00
Loan Term: 10 Years (120 Months)
Interest Rate: 1.81% (Variable/Excellent Credit)
Monthly Payment: $456.00
Monthly Savings: $37.00 per month assuming that the initial variable rate never changes.
Lifetime Savings: $4,534.00 over 10 year loan term assuming that the initial variable rate never changes.
Well, for starters, there’s no such thing as a variable loan which never changes over any decent loan term. The change may not be a huge swing but there is going to be change. As you can see, even with a big $50,000.00 loan, the monthly payment difference ($27.00 per month) and the overall cost difference ($4,534.00) over a 10-year time period, isn’t massive.
The real savings is going from your current student loan to a refinanced student loan where, under the same conditions, you might drop from an 8% to 4% fixed rate and save $100.00 per month and a whopping $12,049.00 over the term of the loan. If you are more concerned with lowering your monthly payment, you could run the refinanced loan at 4.5% over 20 years and lower your monthly payment by $304.00 per month effectively cutting it in half. The lifetime savings would be negligible.
The real money is saved on the refinancing of the loan or loans that you currently have by consolidating them into a single loan at a much lower rate. If the fixed rate is doable for you, I would choose the fixed rate loan while watching the market for potential refinancing if rates really drop. Use the loan term to get to a monthly payment that you are comfortable with by adjusting the term length.
So there you have it. We worked through this together. We gave it some thought and came to some decisions with facts for individuals to consider based on individual needs and thought not based on what some Ivy League digit-head flippantly told us to do. If you would like to see how much you could potentially save while not impacting your credit – at least not until you apply – please check out your options for Student Loan Refinancing on Loan Camel here.
If you are looking to consolidate only federal student loans, in order to maintain the federal loan benefits on those loans only, please see the Federal Student Aid Office of the U.S Department of Education’s Direct Consolidation Loan Application page.