Knowing the basics about interest rates will help you better understand loans — student loans and others. Know before you owe!
Understanding student loan basics will help you reach success! Today we will explore interest rates.
Sadly, borrowing money doesn’t come for free. As we like to say, know before you owe!
Most loans have interest rates, but what exactly is an interest rate? Let’s find out.
To start, when you take out a student loan, you’ll borrow a lumpsum of money. This is amount is called the principal.
Interest is the charge to borrow money. It is calculated as a percentage of the principal.
Here we see:
The principal + The interest = The TOTAL cost of borrowing
Now, not all interest rates are created equal. There are two types of interest rates.
A fixed-rate will never change over the life of the loan so, even when the market fluctuates, your fixed-rate AND payment amount will remain the same.
Variable rates may increase or decrease. This fluctuation depends on the loan index, which is influenced by financial markets. Starting rates may look low but they’ll likely change.
Sarah borrows a $10,000 loan at a fixed rate of 2.75%~ today, next month, or five years from today she will continue to pay 2.75%.
At the same time, Joe borrows a $10,000 loan with a variable rate. With this option, he will be locked into a rate of 2.75% for the first period. However, this rate is subject to change.
Sarah, who selected a fixed rate will pay $107 a month. For a total interest payment of $2,839.
Combined with her initial principal, her total loan payment is $12,389.
Joe who selected a variable rate will not be able to calculate his total loan payment. His total loan payment may be less than or greater than Sarah’s.
Before you take out a loan consider asking the lender these questions.
- Is the interest rate fixed or variable?
- If variable, what is the interest rate’s range?
- AND, how often does the interest rate reset?