Variable or Fixed – Understanding Interest Rates

You may remember that we had a heart-to-heart about how credit card debt interest rates work and we spent some time deciphering what exactly APR is (and how it completely destroys your life).

Looking at the APR allows you to accurately compare the annualized cost of credit for your credit cards, student loans and other debt. For student loans means that APR encompasses interest rate, fees, charges, etc. – so your APR can be higher or lower than the actual interest rate. Still, looking at the APR is the most efficient and accurate way to evaluate the cost to you and compare it to other options. But there is more! A lot of private lenders allow you to choose between fixed or variable interest rate – if I am honest, I probably would have ticked whichever box tickled my fancy at that very moment… but no, not you – you fiscally responsible daisy!

Today, we are going to kick it up a notch (key change à la Queen Bey) and try to wrap our pretty little heads around fixed and variable interest rates. This is of particular importance when considering your options for dealing with student loans – either consolidation or refinancing!

Fixed Interest Rates

For student loans (or any kind of debt) with a fixed interest rate, you will be paying a permanent, static rate of interest for the entire duration of the loan – no matter what happens to the interest rate market during that time. This is a stable option because you can anticipate the exact amount you will pay every month and what the loan will cost you overall.

It is worth noting that your monthly payment may fluctuate if you benefit from an interest rate reduction program or if you are request and are granted a period of forbearance or deferment during the term of your loan.

Variable Interest Rates

A variable interest rate is tied to the interest rate market – variable interest rates rely on the interest rate index that is referenced in your super exciting loan terms and conditions. Two examples are the Prime Index and the London Interbank Offered Rate (LIBOR) Index.

Side note – the Enemy of Fun would tell all of y’all to read those terms and conditions in great, excruciating detail. Barf x a million. But unfortunately, he is kinda right (the worst) – you probably should read those terms and conditions and at least understand the basics… it will save you time and money in the long run.

Variable interest rates are typically a bit lower than fixed interest rates but, depending on the market, can increase over time. Your monthly payment will fluctuate as the interest rate moves upward or downward.

So which is better? There is no hard and fast rule here – it depends on the current state of the economy, where interest rates are, where they are going. Overall, if interest rates are relatively low (and about to increase), you are probably better off with a fixed rate loan at the current rates. But if interest rates are decreasing, you would be better off with a variable interest rate for your loan, so that as the interest rates drop, so does yours!

Sincerely yours in harmonious fun and fiscal responsibility,

Rachel

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