Often, private money lenders offer a scheme of variable rate student loans to loan borrowers who are taking on a new education loan or refinancing their existing loan. These loans, unlike fixed-rate loans which stay the same till repayment, fluctuate over the course of time.
Since variable rate loans have a tendency to keep changing or fluctuating, they pose a higher risk than fixed loans. However, they also have the scope of saving you hundreds or thousands of dollars in interest. Whenever you take out a new student loan or set out to refinance your old one, you will be given the option to choose between variable rate student loans and fixed-rate student loans.
What Are Variable Rate Student Loans?
How do variable rate student loans work? A variable rate loan is defined by how its interest rates are determined or set. Only private student loans have variable interest rates as all federal student loans come with a fixed interest rate.
A variable interest loan implies that the interest rate charged on the loan will change and vary over time. If the interest rate changes, your monthly repayment plan can happen to fluctuate too.
These changing interest rates are not determined by the will or whims of your lender but instead it is the prevailing market conditions in the finance market that determine the variable interest rate.
Most often, private loan lenders set and increase or change variable rates in direct proportion with the London Interbank Offered Rate (LIBOR). This rate is the average of the rates prevailing in the loans exchanged between banks or financial institutions themselves.
A variable interest rate loan varies from the fixed-rate loan because it can either increase or decrease during the course of the repayment period. It is made up of 2 parts- a fixed margin and a variable interest rate index.
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The fixed margin is the only part of variable rate student loans that do not vary over time. It is based on the lender’s analysis of your capacity to repay the loan. How does this work? When you are applying for a private student loan, the lender will analyze the creditworthiness of you and your co-signer. While a variety of methods are used for this analysis, a general rule usually used is if you have a higher credit score, you may get a lower fixed margin.
Variable Interest Rate Index
The second component of a variable interest rate loan is the interest loan index that makes the loan “variable” in nature. The variable interest index is based on a predetermined benchmark that decides the question of how do variable rate loans work? The lender can decide which index to use but they cannot control its use. The most commonly used index is the LIBOR index that we mentioned earlier. As this index rate changes, so does the index part of your variable interest rate. The fixed margin plus the variable interest rate index make up the total amount of interest rate that you are charged with.
Why You Should Opt For Variable Rate Student Loans
Very often, variable interest loans start with a lower monthly payment and can thus save you a lot of money immediately in the short term.
If you are seeking a new education loan or refinancing your old student loan, here are some of the reasons to watch out for variable rate student loans-
- If you anticipate that the interest rate will remain low for a while
- You are seeking cheap initial repayments- one of the main reasons to watch out for variable rate student loans.
- You are opting for a short repayment period
- You are going back to college and want to refinance your old private student loans.
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