Fixed-Rate Student Loans, With a Catch

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Smart Money
By: Annamaria Andriotis
August 17, 2011

Now borrowers can swap the potential for higher rates later with the certainty of higher rates now

With tuition bills due in a few weeks, a growing number of banks are offering stretched parents and students new, fixed-rate loans that promise protection from the specter of rising rates -- for a price.

Until recently, most private student loans have carried variable rates, where the interest rate can adjust up or down each month. But now, for borrowers nervous about rising rates, lenders are advertising loans with interest rates that remain fixed for the term of the loan, typically 10 to 15 years. At least 12 lenders now offer fixed-rate loans, nearly double the number from a year ago, according to FinAid.org. Since May, Wells Fargo, U.S. Bank, Citizens Bank and Charter One have all introduced fixed-rate loans for students. And banks that haven't gotten on the bandwagon will probably do so soon, says Mark Kantrowitz, publisher of FinAid.org and Fastweb.com. That could make these new fixed-rate loans a permanent part of the college-lending landscape.

These loans have the same appeal fixed-rate mortgages do: The payments are fixed, which makes budgeting easier and protects borrowers from possible interest-rate spikes. But in the case of these new loans, the fixed interest rates may already be somewhat higher than what a variable rate loan would risk. Fixed-rate private student loans typically start at around 6.25%, then climb to 14.25%, based on the credit scores, employment status, and assets of the borrower and co-signer.

Compared to other loans, that's not much of a bargain. Undergraduate students whose parents claim them as dependents may qualify for a total of $31,000 in federal Stafford loans, with fixed rates that currently range from 3.40% to 6.80%. Their parents can qualify for a federal loan at a fixed rate of 7.9% for any costs of attendance not covered by other aid.

The rates on traditional, variable-rate student loans start off even lower: Parents -- or students with stellar credit and plans to pay off their loans quickly could pay as little as 2.89%. In some cases, even the most expensive variable-rate loans can be lower than the private fixed-rate alternative. At Wells Fargo, variable rate loans start at 3.5% and go as high as 9.99%, while its fixed-rate loans range from 7.75% to 14.25%.

Of course, if rates rise, borrowers' monthly payments on variable-rate loans would rise too. But last week, the Federal Reserve announced its intention to keep its interest rate low until at least mid-2013, which should keep the prime rate unchanged. So for that Wells Fargo variable-rate loan to reach the same interest-rate as the most expensive fixed-rate loan, for example, the prime rate would have to more than double, from 3.25% to 7.51%.

The banks say that fixed-interest rates help families know how much they'll have to pay each month for the life of the loan. And they say that other help that has previously been available to pay for college is either dwindling or not keeping up with costs. With tuition costs rising, less free aid to go around, and stock market losses that have crippled some families' savings plans, loans are one of the few ways for families to pay for college right now.

But if need be, even other kinds of private loans may be a better deal than most of the new fixed-rate student loans. The rates on home equity loans now average 6.84%; home equity lines of credit are even less, at 5.42% on average, according to Bankrate.com. Even credit cards, typically not a top choice for big-time borrowing, are competitive, with an average interest rate of 14.56%, according to credit-card comparison web site CardHub.com, and someone who signs onto a 0% promotional offer for 21 months, then carries a balance for, say, another two years, would pay an effective rate lower than 8.19%.

In general, borrowers, especially those with less-than-stellar credit, will get a better deal with federal student loans. For credit all-stars who need more than what the federal government will lend, it becomes a question of how long they think it will take to pay down the loan. Rates aren't expected to rise any time soon (and it would take quite a jump to get them into fixed-rate territory), so borrowers who expect to pay down their loans quickly could save with a variable-rate loan right now.

Of course, most borrowers don't repay their student loans so quickly. On average, they take 16 to 18 years to repay this debt, according to FinAid.org. Those borrowers, especially those who qualify for the lowest rates, may appreciate the certainty in the fixed-rate loans.

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This page contains a single entry by CFED published on August 17, 2011 3:41 PM.

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