Lock-in Interest Rates

Paying back your student loans can be a daunting process. Sure, you understand that you have to pay back $30,000 in loans over the next ten years. However, when you signed on the dotted line, you may not have paid too much attention to the interest rates on the loans. In fact, you probably did not even pay attention to whether the interest rates were fixed or variable. Now, the time has come to start paying back those loans. You discover the actual amount you owe is much higher than the original amount you borrowed.

There are two types of student loans: federal and private. Federal student loans have fixed interest rates if they were awarded after July 1, 2006. This means that your interest payments will remain the same over the life of a loan. You can easily calculate exactly how much your student loan payment will be each month. Knowing your monthly payments will help you be able to better plan your finances.

Private student loans typically do not have fixed interest rates. Banks will charge variable interest rates, based on market conditions. When the economy is soft, interest rates are generally lower. When the economy is growing and strong, interest rates will soar. Banks may decide to adjust their interest rates quarterly, annually, or even monthly. This makes calculating your monthly payments more difficult and can present challenges when planning your finances. Since interest starts accruing as soon as the money is distributed, you may find that your interest is equal to the entire amount of your loan!

Let’s look at an example situation that many people find themselves in. You signed a loan agreement during an economic recession. Initially, your interest rate was a low 3.5%, but your loan agreement stated that you would be charged a variable interest rate. You weren’t too concerned because you thought the interest rate would only increase slightly. Now, five years later, the economy is growing and so is your rate. You are now being charged a whopping 8.5% interest rate! If that rate had been fixed, you would have saved yourself hundreds, if not thousands of dollars. However, you do not have to keep these variable interest rates on your private student loans.

The Process
The process of student loan consolidation does not just help you lower your monthly payment and reduce your interest rates. Consolidating your loans will also let you lock in your interest rate, which will provide you with some financial stability. You will now be able to calculate exactly what your monthly student loan payments will be and adjust your spending habits accordingly. You no longer have to worry that the bank will increase their rates by 5% one month, 2% the next month, and remain steady for three months.

Each consolidation company has their own method and statistical models that they use to determine your fixed interest rate: Sometimes it is a blend of rates from your portfolio of loans, a pre-determined average, market factors, or a mix of lender’s rates. If you have been able to improve your credit score, you may be able to receive a lower fixed interest rate. It is important to speak with a few different companies to make sure you are getting the best fixed rate possible.

You will not be able to shop around every few years to find a better fixed interest rate. Once you consolidate your student loans, you are stuck with the new fixed interest rate. Remember, interest rates ebb and flow with the economy. Some people try to hold out and consolidate when the economy softens. However, not everyone has that luxury. Always calculate what your “anticipated” interest payments will be versus the new fixed rate (include best- and worst-case scenarios). You may be surprised by what you discover. Make sure you do not end up signing an agreement that puts you in a worse financial predicament.