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Interest rates are an important concept to wrap your head around if you’re considering taking out or refinancing student loans, especially when given the option to choose between a fixed or variable interest rate.

Rates on government student loans are always fixed. Private lenders, on the other hand, often offer borrowers a choice of a fixed- or variable-rate loan.

An interest rate is the amount charged by a lender for the use of the money you are borrowing. Broadly speaking, the interest rate is an annual rate you pay on your outstanding loan balance. If you start out with a $10,000 loan balance at an annual interest rate of 5 percent, you’d expect to pay about $500 per year in interest.

Charging interest is one of the main ways that lenders make money. Additional loan expenses — such as origination fees or monthly service charges — can be factored into what’s known as your effective annual percentage rate (APR).

Private lenders try to charge enough interest to compensate for the fact that some people they lend to won’t pay them back. In addition to pricing in risk of default and other expenses, private student loan lenders try to build in a profit margin that makes them competitive with other lenders.


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Fixed and variable interest rate definitions for student loans

Just to make sure we’re all on the same page, let’s give some basic definitions of fixed and variable interest rates as they apply to student loans.

Variable Interest Rate

A variable interest rate is determined by the market, meaning that it may fluctuate over time. If market rates are low, your variable interest rate will remain low. If they rise, your variable interest rate will rise with them. If market rates remain stable, your variable interest rate will hold.

This means that your monthly payments on student loans may go up or down month-to-month, according to variable interest rate changes.

Fixed Interest Rate

Fixed interest, on the other hand, is determined by a lender’s projections about student loan rates over time. They do not fluctuate throughout the period of a loan. That way, as a borrower, you can predict your payments with more certainty.

If market rates rise or fall, your interest rate will remain the same.

Fixed vs. variable student loan interest rates

Depending on the type of student loan you take out, you may be offered a choice between a fixed or variable interest rate loan. The difference is simple: The rate on a variable interest rate loan can change over the life of a loan, whereas a fixed rate will remain the same unless you refinance it.

Rates on federal student loans are fixed, and everyone taking out the same type of loan at the same time gets the same rate. The interest rate on federal student loans depends on the type of borrower, and when they took out their loan. Rates for new loans are adjusted annually, and different types of borrowers (undergrads, grad students and parents) pay different rates.

Looking back from 2006 to 2018, average rates for federal student loans were 4.81 percent for undergraduates, 6.38 percent for graduate students, and 7.44 percent for parents and graduate students taking out PLUS loans.

There’s no evaluation of your ability to repay when you take out federal student loan. That can be a good thing if you have little credit history, or would be considered a high-risk borrower by a private lender.

If you have good credit however, you may qualify for better rates from private lenders — particularly once you’ve graduated and are earning a good income. Check out the table below to see fixed and variable interest rates for top refinancing lenders.

Best refinancing lenders: fixed vs. variable interest rates

LenderVariable rates from (APR)Fixed rates from (APR)Check rates from multiple lenders in 2 min
advantage education loan consolidationN/A4.54%+Get Rates
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brazos student loan refinancing3.45%+4.79%+

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citizens bank student loans3.00%+¹3.89%+¹Get Rates
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edvestinu student loan consolidation5.37%+4.93%+Get Rates
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elfi student loans2.80%+33.39%+3Get Rates
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mefa refinancing4.70%+4.45%+Get Rates
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penfed purefy student loan consolidation3.11%+3.75%+Get Rates
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rhode island student loan authority refinancingN/A3.49%+Get Rates
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All APRs reflect autopay and loyalty discounts where available | 1Citizens Bank Disclosures | 3ELFI Disclosures

Citizens Bank Education Refinance Loan Rate Disclosure: Variable rate, based on the one-month London Interbank Offered Rate ("LIBOR") published in The Wall Street Journal on the twenty-fifth day, or the next business day, of the preceding calendar month. As of April 1, 2019, the one-month LIBOR rate is 2.50%. Variable interest rates range from 3.00%-9.74% (3.00%-9.74% APR) and will fluctuate over the term of the borrower's loan with changes in the LIBOR rate, and will vary based on applicable terms, level of degree earned and presence of a co-signer. Fixed interest rates range from 3.89%-9.99% (3.89%-9.99% APR) based on applicable terms, level of degree earned and presence of a co-signer. Lowest rates shown are for eligible, creditworthy applicants with a graduate level degree, require a 5-year repayment term and include our Loyalty discount and Automatic Payment discounts of 0.25 percentage points each, as outlined in the Loyalty and Automatic Payment Discount disclosures. The maximum variable rate on the Education Refinance Loan is the greater of 21.00% or Prime Rate plus 9.00%. Subject to additional terms and conditions, and rates are subject to change at any time without notice. Such changes will only apply to applications taken after the effective date of change. Please note: Due to federal regulations, Citizens Bank is required to provide every potential borrower with disclosure information before they apply for a private student loan. The borrower will be presented with an Application Disclosure and an Approval Disclosure within the application process before they accept the terms and conditions of their loan.

For variable and fixed-rate loans offered by private lenders, interest rates will typically depend on the length, or term of the loan, and the perceived credit risk of the borrower. All other things being equal, the shorter the loan term, the lower the rate.

While rates on variable interest loans typically start out lower than those for fixed-rate loans, they are also less predictable. Let’s dive a little deeper.

You can learn more about the best refinancing and consolidation companies, and the rates they offer.

Pros and cons of fixed vs. variable interest rate loans

 Fixed-interest rate Variable-interest rate
Interest rateThe rate you start with is the rate you’ll have throughout the term of the loan.The rate can periodically increase or decrease along with the reference rate (such as LIBOR or the prime rate) it's indexed to.
Monthly paymentYour monthly payment will remain constant throughout the term of your loan (unless you choose an income-driven repayment plan).Your monthly payment can fluctuate depending on changes in the interest rate.
Pros• Certainty of the same rate and monthly payment throughout the term of the loan.• Generally offers a lower rate at the outset.
• If the reference rate does not rise, can provide a lower overall repayment amount compared to a fixed-rate loan.
Cons• Interest rate will generally be higher than variable-rate loan with the same repayment term.• Less predictability in terms of your monthly payment amount.
• Possibility of your interest rate increasing in the long term (variable rates are often capped, but that cap is often high, at 15%-18%).

Many college and personal finance advisers recommend that you minimize your college expenses and take advantage of all available aid, scholarships and federal student loans available to you before turning to private lenders.

Since all new federal student loans carry fixed rates, you may never have to contemplate the pros and cons of fixed- and variable-rate loans. But, if you need to turn to private lenders to refinance or take care of additional school expenses, here’s how to weigh a fixed-rate loan vs. a variable-rate loan.

Fixed interest rate student loans

Fixed interest rates are usually set at the time of your agreement and don’t change for the life of your loan. The advantage is that you always know how much you will be paying.

The downside of a fixed-rate loan is that you might be passing up the chance to start out making lower monthly payments. Rates on variable-rates loans are lower than fixed-rate loans because you, not the lender, are taking on the risk that rates will increase.

Although they’ve been heading up recently, interest rates for federal student loans are still below historical highs, so a fixed-rate loan might be a safe bet. If rates keep going up, the savings you might start out with by choosing a variable interest loan could evaporate.

If interest rates happen to be high when you take out a fixed-rate loan and end up falling, you might be able to refinance your loan in order to take advantage of the savings.

Variable interest rate student loans

Variable rates can either work for you or against you. During tough economic times, the Federal Reserve and other central banks reduce short-term interest rates in the hopes of encouraging lending that can kick-start growth. When the economy shows signs of heating up, the Fed starts worrying about inflation, and policymakers may decide to raise rates in order to keep prices from rising too sharply.

Variable-rate loans are typically indexed to reference rates, which are benchmarks like the prime rate or the London Interbank Offered Rate (LIBOR) that fluctuate with the economy. The lender will add a margin on top of the reference rate that’s aimed at offsetting the risk that the borrower won’t repay the loan and to make a profit.

Basically, the greater your perceived credit risk at the time of the application, the greater the margin (applying with a cosigner can help lower the rate). When central banks make adjustments that raise or lower the cost of short-term borrowing, other rates will follow, including the interest rate on your variable-rate loan.

Variable-rate loans may adjust monthly, quarterly or annually. Some come with a periodic cap limiting how much your rate can increase during each period. Others may also have lifetime caps limiting how much the rate can go up over the life of the loan.

As the chart below demonstrates, the two most commonly used reference rates for variable-rate student loans — LIBOR and the prime rate — can swing dramatically in a relatively short period of time.

The gray bands in the chart above represent recessions. Interest rates plunged in 2008, when policymakers took drastic measures to stimulate growth in the wake of the mortgage meltdown and global recession.

It took some time for those measures to take effect, but Fed policymakers started gradually raising rates in December 2015. Although interest rates have seemingly little leeway to move in any direction but up, it’s hard to predict when, or how fast, they’ll rise.

The historical chart above can’t tell you where interest rates will be in the months or years ahead. But it can give you an idea of how far they can swing, and how fast. Pulling the slider bar on the chart lets you look back farther in time.

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The interest rate environment: why rates are so low right now

In December 2015, as the U.S. continued on the road to recovery from the Great Recession, the Fed raised its target for a key short-term interest rate (the federal funds rate) for the first time since 2006.

Although the decision worried some borrowers, the Fed makes changes gradually. Since its initial nudge, the Fed has been gradually increasing short-term interest rates. Each increase has been one quarter of a percentage point.

Borrowers who already have federal student loans won’t see any difference in their rates from these rate increases, since rates on federal loans are fixed for the lifetime of the loan.

Rates on government loans issued from July 1, 2018 through June 30, 2019 will range from 5.05 percent for undergraduate loans to 7.60 percent for Direct PLUS Loans issued to parents and graduate or professional students. If you’re planning to take out federal loans after that, you might pay even higher interest rates.

More: Should you consolidate your student loans

How interest rates on federal loans are set

Rates on federal loans are determined by Congress, and can depend not only on how the economy is doing, but political sentiment. Since a 2013 overhaul of the Higher Education Act, interest rates on federal direct loans are set annually, according to a formula that uses rates for 10-year Treasury notes as a benchmark.

Rates for all federal student loans increased by 0.69 of a percentage point in 2017 and another 0.60 percentage points on July 1, 2018. Together, the increases mean rates on federal student loans for students taking out loans for the fall of 2018 will be 1.29 percentage points higher than they were two years ago.

To determine the rate for undergraduate loans, the Department of Education tacks 2.05 percentage points onto the rate for 10-year Treasury notes auctioned in May. The add-on for federal direct loans for graduate school students is 3.6 percent, while rates for PLUS loans are equal to the 10-year Treasury note yield plus 4.60 percentage points.

So if you’re wondering where rates on government loans might be headed in years to come, keep your eye on the 10-year Treasury note. If rates on 10-year Treasury notes go up or down, so will rates for new federal student loans.

As the chart above demonstrates, long-term rates like 10-year Treasury notes don’t always track short-term rates like LIBOR exactly, but there’s a correlation. Note how during the last 20 years, long-term and short-term interest rates both took a dive in 2001 (in the aftermath of the dot-com bust) and 2008 (in the wake of the housing crash), and stayed depressed for a while.

If you had to guess, which way would you say interest rates are headed next?

Pull the slider bar on the chart to go back even farther in time, and you’ll see another pattern in long-term rates during the last 10 recessions (represented by gray bars) stretching back into the 1950s.

If you’re younger than 40 or 50, check out the inflationary period in the 1970s. It might be a revelation that when oil prices and government borrowing are running rampant, interest rates can go UP during a recession (1974). And take note that rates on 10-year Treasurys are ultimately driven by markets. They can get into the double digits, even if nobody really wants them to be that high.

There are two caveats about rates on government student loans to keep in mind: First, the formula mandated by the Higher Education Act imposes an 8.25 percent cap for federal direct loans to undergraduates, and 9.5 percent for direct loans to grad student loans. The cap for PLUS loans is 10.5 percent.

Second, there’s no law that says Congress can’t change the rules that determine government student loan rates again. If rates on 10-year Treasury notes soar, lawmakers — particularly Democrats — may be reluctant to let rates on government loans approach the currently mandated caps. Some Republicans who champion market principles might argue that rates should be allowed to exceed the caps.

Fixed Rate vs. Variable Rate: How does interest affect you?

Life would be easier if you could predict whether interest rates were going to rise or fall, and when. But of course, you can’t — so how do you decide whether a fixed or variable rate might be better for you?

Generally speaking, this depends on how risk-averse you are. If you’re relatively comfortable with uncertainty or are fairly confident that interest rates aren’t going to dramatically increase, you could consider a variable rate. A variable interest rate might also work for you if you think you might be able to pay more than just the minimum amount every month, thereby shortening the length of your loan.

If you know you’ll need to borrow a lot of money to graduate from college that will take many years to repay, a fixed-term loan at today’s interest rates could be a real bargain in a decade or two. Because inflation will probably erode the value of the dollar — and pump up your paycheck — a fixed-rate loan should get easier to repay over time.

The good news is that if you’re in a variable-rate loan that starts to get more costly, it’s often possible to refinance into a fixed-rate loan.

Find out if you qualify for a lower rate by comparing your options with Credible. You can compare offers from a variety of vetted lenders, without having to share any sensitive information, or incur a hard credit pull.

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Ariha Setalvad <> is a Credible staff writer. Follow us on Twitter at @Credible.