By Ryan Lane
Federal student loan interest rates hit record lows on July 1. But those rates are still higher than what some private lenders are offering.
Multiple lenders, including Sallie Mae, SoFi and Citizens Bank, now advertise minimum variable loan interest rates below 1.5%. At this time last year, the average minimum variable rate for private student loans was 4.89%, according to NerdWallet data.
Rates for online lender College Ave start at 1.24%. The company’s CEO, Joe DePaulo, says it’s their lowest rate ever and that more College Ave borrowers are opting for variable rates this year.
But variable rates change, and that risk isn’t for everyone — even for a rate near 1%. Here’s how to tell if it’s right for you.
You Can Qualify for the Lowest Rate
Students should max out federal loans before turning to private options. Interest rates on federal loans are fixed and as low as 2.75% for the upcoming school year.
All eligible federal borrowers get the same rate, whereas private lenders base rates on credit and other factors. That means you may not actually qualify for 1% interest.
For example, College Ave’s lowest rates are for borrowers who have excellent credit, choose the shortest repayment term (five years) and make full payments immediately, according to DePaulo.
He says 40% of the lender’s borrowers defer payments, making them ineligible for the lowest advertised rate.
Compare offers from multiple lenders before applying to find the lowest rate you can get. Pre-qualifying with lenders won’t affect your credit.
You Can Afford to Potentially Pay More
Variable rate student loans are tied to a financial index, typically the London Interbank Offered Rate, or Libor. Variable rates change monthly or quarterly with that index.
Because a 1% rate is already low, it’s more likely to increase than decrease.
“I don’t see [rates] going down anymore,” DePaulo says.
How much your rate might rise will depend on a loan’s terms. Look in the loan agreement for the rate’s cap and its margin, or how much more than the index your rate is.
For example, if the Libor is 0.30% and your margin is 2%, your rate would be 2.3%. If the Libor rose to 2.3% — roughly where it was a year ago — your interest rate would increase to 4.3%.
For a $10,000 student loan on a 10-year repayment term, that change would lead to twice as much interest accruing on your loan each month and higher bills as a result.
The Savings Outweigh The Risk
Your variable rate may never reach its cap, but you should be prepared if it does.
Using a student loan calculator, figure out what your initial payments would be with a variable rate loan, as well as the maximum possible payment.
“One of the things I’ve learned is to never guess where rates are going,” says David Klein, CEO of online lender CommonBond, whose lowest advertised variable rates are currently 1.43%.
Compare variable rate payments to payments on a fixed rate loan. While fixed rates aren’t 1%, Klein says the difference in payments may be “incredibly low” in the current market and make the risk of a variable rate not worth it.
For example, CommonBond advertises fixed rates as low as 5.45%. For a $10,000 loan repaid over 10 years, that would mean monthly payments of roughly $108. At 1.43%, those payments would be about $90.
If you feel the savings are substantial, evaluate a variable rate loan as part of your entire student debt. For example, are you starting school? If so, a variable rate may have years to rise — and accrue interest — before you start repayment.
Alternatively, you may be close to graduation and able to start repayment quickly. And once you leave school, you can consider refinancing variable student loans if rates start to rise. Fixed and variable refinance rates are also low currently.
Klein says there’s no blanket advice for borrowers, except to know what you’re getting into with a variable rate product.
“If you are someone who fully understands the market interest rate risk … and is ready, willing and able to take that on eyes wide open,” says Klein, “then you should consider it.”
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Ryan Lane is a writer at NerdWallet. Email: email@example.com.