Differences Between Fixed & Variable Student Loan Interest Rates

The choice between a fixed rate and a variable rate isn’t overly difficult; it comes down to a few key distinctions, including economic influences and your student loan terms.

Fixed vs. Variable Annual Percentage Rates
Fixed Variable
Stays the same for the life of the loan. Changes monthly or quarterly, increasing or decreasing.
Predictable monthly and total payments. Unpredictable monthly and total payments.
All student loan refinance lenders offer fixed APRs. Not all student loan refinance lenders offer variable APRs.
Rates are usually higher than starting variable rates. Usually the lowest advertised rate.

Fixed vs. Variable Rates

Conventional wisdom is the lower the interest rate, the better the deal. This does not take into account the way interest rate indices change over time, however.

Financial advisors usually recommend a fixed rate over a variable rate; fixed rates aid financial planning and avoid the risk of a spike in interest rate indices.

There are few conditions under which a financial advisor would recommend adopting a variable rate. Such situations may include a low-balance, short-term loan under certain economic circumstances; this is due to how lenders determine interest rates, and in particular, how they use their preferred interest rate index.

Line Graph: 30-Day Secured Overnighht Financing Rate (SOFR) Index, Rates as Posted on the First Day of the Financial Quarter, from 2019Q1 (2.37), 2019Q2 (2.42), 2019Q3 (2.40), 2019 Q4 (2.20), 2020Q1 (1.54), 2020Q2 (1.59), 2020Q3 (0.08), 2020Q4 (0.09), 2021Q1 (0.08), 2021Q2 (0.04), 2021Q3 (0.03), 2021Q4 (0.05), 2022Q1 (0.05)

Variable Interest Rates Explained

Variable interest rates tend to start a little lower than fixed rates, but that doesn’t necessarily mean you’ll save more. Private lenders set variable rates at the time of the loan’s origination. Variable rates then change according to interest rate indices, such as the Secured Overnight Financing Rate (SOFR). Lenders typically adjust their variable rates either monthly or quarterly.

Some borrowers with shorter loan terms still opt for a variable rate; from 2009 to 2015, interest rates were stable and historically low. If you do select a variable rate and it later increases significantly, you may have the option to refinance again at a fixed rate.

Note that interest rate indices have been reset to historic lows in the wake of COVID-19. The Federal Reserve has disclosed plans to raise interest rates in coming months.[1]

Transition From LIBOR

The London Interbank Offered Rate (LIBOR) was once the go-to reference rate for student loan refinance lenders. Due to a global financial fraud scandal, however, the LIBOR will be discontinued in 2023. Refinance lenders that use the LIBOR to calculate their variable rates will switch to an alternative. Some have already changed reference rates while others have stopped offering variable rates altogether.

Line Graph: Prime Loan Rate, Rates as Posted on the Last Day of the Previous Quarter, from 2019Q1 (5.35), 2019Q2 (5.5), 2019Q3 (5.5), 2019Q4 (5.15), 2020Q1 (4.75), 2020Q2 (3.78), 2020Q3 (3.25), 2020Q4 (3.25), 2021Q1 (3.25), 2021Q2 (3.25), 2021Q3 (3.25), 2021Q4 (3.25), and 2022Q1 (3.25)

Alternative Reference Rates

Among refinance lenders that have stopped using the LIBOR, the Secured Overnight Financing Rate or SOFR is a popular alternative. Prime Rate is another common index. It bears noting that indices tend to experience similar peaks and valleys because they are influenced by similar economic factors.

Fixed Interest Rates Explained

Fixed interest rates are generally recommended because they remain the same for the life of the loan. A steady rate lets borrowers determine exactly how much interest they’ll pay and when (provided they make all payments in full and on time).

A fixed rate not only allows you to predict how much you’ll ultimately pay, but it also lets you know exactly how much you’ll save by refinancing. In essence, fixed rates are safer and more conservative. This is ideal for most student refinance loans.

All federal student loans use a fixed rate only. It is possible to refinance federal loans at a variable rate with a private lender, but this is generally not recommended. In addition to the potential for a rate spike, refinancing also invalidates any special protections or benefits for which federal student loans are eligible.

Sources

  1. CNBC, The Fed Moves Up Its Timeline for Rate Hikes as Inflation Rises
  2. Federal Reserve Economic Data (FRED), 1-Month London Interbank Offered Rate (LIBOR), based on U.S. Dollar
  3. FRED, Bank Prime Loan Rate
  4. U.S. Department of Education Office of Federal Student Aid, Student Loan Repayment