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 have the power to make a more educated decision that best fits your current and future financial needs. In Part I of this article, we covered repayment plan options. Now, we’ll review interest rate types and repayment terms to help guide you to the best student loan option for you.
Interest Rate Type
For borrowers taking out private student loans or refinancing their current student loans, there are a few interest rate options to choose from:
- 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 to you, 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, since 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 and then it switches to a variable rate for the remainder of the loan period.
Tip: If you intend to pay off your loans in a relatively short period of time, you may be better off with a variable rate loan. However, if you plan to take a bit longer to pay off your loans, or you 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, and 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, while some lenders offer repayment terms as long as 20 years.
When determining what the interest rate on a private student loan will be, a good rule of thumb is that the shorter the repayment term you select, the lower the interest rate you will be charged. This is due to the lender taking on additional risk by allowing you to repay your loan over a longer term.
Tip: Your monthly payment amount is determined by the principal balance of the loan when you start making payments, the interest rate on the loan, and the repayment term. Since shorter repayment terms come with lower interest rates, but higher monthly payments, be sure to choose a repayment term with a monthly payment you can afford, especially when you are first starting out.
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, so if down the road you find you can afford to pay more each month than the minimum required, you can increase your monthly payment and pay down your loan faster without being charged any pre-payment fees, reducing your overall cost of borrowing.
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.