With the numerous private student loan repayment options available, selecting the right one can seem a bit overwhelming. However, with a little bit of knowledge, you can make a more educated decision. In Part I of this article, we covered repayment plan options. Now, we’ll review interest rate types and repayment terms to find the best student loan option for you.
Interest Rate Type
Borrowers taking out private student loans or refinancing their current student loans have a few interest rate options.
- Variable: Variable rate loans have an interest rate that can fluctuate over time as the rate index, such as the Prime Rate or LIBOR, goes up or down. Variable rate loans typically come with lower starting interest rates than comparable fixed rate loans. However, they come with greater risk, since rates may rise in the future. Most variable rate loans have a cap that places a limit on how high the rate can rise.
- Fixed: With a fixed rate loan, once the rate is set, it does not change for the entire repayment period. Fixed rate loans normally have higher starting rates than variable rate loans. This is because the lender takes on the risk of interest rates fluctuating over time.
- Hybrid: Another less popular option is a hybrid rate loan. With a hybrid rate loan, the interest rate is usually fixed for a period of time. It then switches to a variable rate for the remainder of the loan period.
Tip: If you intend to pay off your loans in a short period of time, consider a variable rate loan. If you plan to take longer to pay off your loans or prefer stable, predictable payments, a fixed-rate loan may be the best choice. When deciding which type of rate to choose, use the lender’s loan repayment calculator to estimate the savings between a variable rate and a fixed rate loan. Also decide whether the estimated savings is worth the additional risk of a variable rate loan.
Another important item that determines the interest rate you will be charged is the repayment term you select. Most lenders offer private student loans and refinance loans with repayment terms between 5 and 15 years. Some lenders offer repayment terms as long as 20 years.
When determining interest rates on private student loans, remember that the shorter the repayment term, the lower the interest rate. This is because the lender takes on additional risk by allowing you to repay your loan over a longer term.
Tip: Your monthly payment amount is determined by several factors. These include the principal balance of the loan when you start making payments, the interest rate, and the repayment term. Shorter repayment terms come with lower interest rates, but higher monthly payments. Choose a repayment term with a monthly payment you can afford, especially when you are first starting out.
Choosing Your Best Option
Choosing the repayment option that best fits your current and future needs can be a bit tricky. But, with a little planning and thought, you can zero in on the loan terms that are best for you. If you find your financial situation changes down the road, and your current repayment terms no longer meet your needs, you may be able to work with your lender to modify your repayment terms. If that isn’t an option, then you can look at refinancing your student loans and replace them with a new loan that is a better fit.
Tip: Most private student loans do not have any pre-payment penalties or fees. If down the road you can afford to pay more than the minimum each month, you can pay down your loan faster without being charged any pre-payment fees. This reduces your overall cost of borrowing in the end.
Understanding the nuances of private student loans can make a big difference when deciding which one is right for you. Making the right choices when taking out student loans can have a strong impact in positioning yourself for a bright financial future.