If you only have a single loan for your post-secondary schooling, the interest rate is obvious and easy to understand. Unfortunately, most students have several loans, based on how long they attended school and what types of lending programs they used.
If you are thinking of consolidating your loans, it’s important to factor in the interest rate of your current loans to compare them to a consolidated loan rate.
Your student loans are probably variable, which means the rate will change according to the current Treasury Index. However, since July 1, 2013, even variable rate loans will have a fixed portion.
There are two parts to a variable rate loan. The base and the spread. As it sounds, the base is the starting part or bottom part of the rate. In this case, the Treasury Index is the base. Since the Treasury Index changes, the base is the variable portion of the rate.
The spread is the percentage between the base (Treasury Index) and the full interest rate. The spread is the fixed portion of the variable rate.
The Treasury Index is 2% and the spread is 4%, therefore, you are paying a total of 6% interest. Let’s say the Treasury Index changes to 2.25%. The base of your rate will change, but the spread remains the same. Therefore, 2.25% with a fixed spread of 4% is now a 6.25%. No matter what happens to the base, up or down, the spread will remain fixed at 4%.
Student consolidation loans have a single fixed rate for the term of the loan. However, when dealing with multiple loans, the rate is calculated using a weighted average to determine how much the interest should be.
Some loans may have higher rates than others, so this helps ensure a fair interest distribution. The weighted average is calculated by using a mathematical formula, which is available in Microsoft Excel. You will need to know the balance of each loan and the applicable interest rate to find the weighted average.
Nevertheless, even if you have a few very high variable rates, the interest rate on student consolidation loans is capped at 8.25%. No matter what your weighted average comes to, you can be assured it will not go higher than the cap.
If anyone actually knew which was better, the other would quickly become obsolete. It’s possible a variable rate will go down, or just as possible it will go up. Fixed, on the other hand, stays the same making it easy to manage and budget.
When it comes to consolidation loans, fixating on the interest rate may distract you from making a well-informed decision. Fixed interest rates work very well on consolidation loans because it allows the borrower to plan and budget repayments with no surprises.
Furthermore, any financial guru will tell you that interest won’t matter if you pay down the principle. Consolidation loans allow you to make additional payments so you can pay them off ahead of schedule. This, more than anything else, will save you the most money in interest, whether your rate is fixed or variable.
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