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Evaluating a Variable Rate Student Loan

Posted by & filed under Financial Intelligence, Mike’s Insights.

There are a lot of factors to take into account when choosing a student loan – differing interest rates, private vs. public, the pros and cons of working with various lenders.  Among those choices, we at SoFi have found one of the things that trips up borrowers the most is the choice between fixed rate and variable rate (also known as floating rate) loans.

Variable rate student loans generally offer a lower starting rate than fixed rate loans, but because that number is tied to prevailing interest rates, payments can change over time.  If the borrower isn’t able to pay the loan back in a relatively short time period, the benefits of the initial lower rate can be fleeting – particularly with an uncapped loan.

SoFi’s variable rate loan is tied to 1-month LIBOR, which is the interest rate at which banks lend to each other.  Like all prevailing rates, LIBOR has been at record low levels since the recession began in late 2008, but as the Fed continues to taper its policy of quantitative easing, interest rates are generally expected to rise.  Today LIBOR is at 0.19%, and has ranged from its current low to as high as 5.82% in the past 10 years (see below).

sofi_libor_chart_v01

So given the current economic environment, how does a borrower know if a variable rate loan is right for them?  Let’s walk through an example to find out, comparing the SoFi 10-year variable rate loan at 1-month LIBOR + 3.75% (the rate that most of our borrowers would receive) with federal student loans at their current fixed rates.

Let’s say you’ve borrowed $50K to finance your student debt, and you’re about to enter the repayment period.  Now we’ll take a look at three potential scenarios in which prevailing interest rates change in order to see how they would affect your variable rate loan – your total payment over the life of your loan and your maximum monthly payment – over the next ten years:

Scenario #1: 1-month LIBOR rises to 5.82% (its 10-year high)
Scenario #2: 1-month LIBOR rises to 11.64% (2X its 10-year high)
Scenario #3: 1-month LIBOR rises to 2.91% (half of its 10-year high)

sofi_variable_scenarios_v01

In Scenario #1, where rates rise to their 10-year high level, the variable rate SoFi loan still beats all but the lowest fixed rate loan on the federal side.  In Scenario #2, where rates rise to twice the 10-year high level, SoFi still has the edge in terms of total payments – again beating out all but the lowest rate federal loan. How is that possible?  Because rates are starting out very low today, and the variable rate SoFi loan is capped at 8.95%.  Having a cap on a variable rate loan can remove some of the risk if you’re concerned about interest rates going sky high.  And finally, in Scenario #3, where rates only go up a small amount, the variable rate SoFi loan has a better outcome than all of the federal options.

Now, this example is really intended to illustrate how variable rate and fixed rate loans create different outcomes in a changing interest rate environment.  Since individual situations could vary from above, you can talk to one of our savings consultants to get a better feel for which loan is right for you.  The SoFi team is standing by at 1-855-456-SOFI.

Views expressed in this post are that of Mike Cagney, CEO of SoFi. 

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4 thoughts on “Evaluating a Variable Rate Student Loan

  1. Louis mazzarelli says:

    Considering variable vs 5 year fixed. 28k in loans to repay. Will prepay with a target full repayment in 2.5 years. Looking for advise on my refinance. FICO 782.

  2. This is super super helpful. I’m evaluating options for b-school loans right now and SOFI is one of the options I’m considering. The variable rate loan looks interesting. If the LIBOR raises too high, is there an option to refinance to a fixed-rate loan? How fast can one refinance and what are the fees/penalties associated with it?

    • Thanks for your interest in SoFi! While a variable rate will move up as LIBOR increases, we cap ours at 8.95% which is lower than most lenders who cap variable rates in the high double-digits. That being said, you are always welcome to reapply to RE-refinance your loan with us. There are currently no fees/penalties associated with this – you can RE-refinance to switch between interest rate types or, if your financial situation improves, to see if you qualify for a better rate.

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