A frowning piggy bank wears a graduation cap while being squeezed by a clamp with the phrase Student Loans written on it

The Impact of Rising Rates on Student Loans 

Student loan debt is the second highest consumer debt category in the United States, with former students owing over 45 million dollars in student debt. Understanding the interest rates, charges and how rising rates impact the loans, can help you better manage the debt and speed up your loan payoff.

Interest rates fluctuate based on the economic conditions and can change annually. For new loans originated in the 2018-2019 academic school year, the rates will rise, increasing the cost of new debt for undergraduate and graduate students.

How Student Loan Interest Rates Are Set

As the Federal Reserve raises rates, the index for student loans also increases, thus making it more expensive to borrow money for college. Every year on July 1st the interest rate is re-set. The Federal student loan interest rate reflects the rates on the 10-year Treasury note, which is determined every year by the final auction before June 1st, plus a fixed margin. The new rate only applies to new student loans for the 2018-2019 school year.

Congress does not determine the rate on private loans. Rather, banks charge market rates based on the applicant’s qualifications, demand, and considerations of what the competition currently charges. The rising interest rates set by the Federal Reserve affect private loans differently from federal loans.

For instance, an undergraduate’s interest rate would be the 10-year treasury note plus a 2.05% margin. In this case, the undergraduate student would have a fixed interest rate of 5.05%, an origination fee of 1.066%, and an interest rate cap of 8.25%.

History of Federal Direct Loan Interest Rates
Academic Year Direct Subsidized Loans (Undergraduate) Direct Unsubsidized Loans (Undergraduate) Direct Unsubsidized Loans (Graduate)
2017-2018 4.45% 4.45% 6%
2016-2017 3.76% 3.76% 5.31%
2015-2016 4.29% 4.29% 5.84%
2014-2015 4.66% 4.66% 6.21%
2013-2014 3.86% 3.86% 5.41%
2012-2013 3.4% 6.8% 6.8%
2011-2012 3.4% 6.8% 6.8%
2010-2011 4.5% 6.8% 6.8%
2009-2010 5.6% 6.8% 6.8%
2008-2009 6% 6.8% 6.8%

Before the 2006-2007 academic year, the interest rates for the Stafford Loans and Direct Loans were variable. Variable loans had different rates based on whether the student was in school, within the 6-month grace period after leaving school, or during the repayment period.

Borrowers could convert the variable interest rate into a fixed rate product through consolidation. At that time, rates were the same for undergraduates, graduates, and professional students. Interest rates were also the same for subsidized and unsubsidized loans.

In addition to the interest rate, students also pay a current fee on direct loans of 1.066% for debt disbursed between October 1, 2017 and September 30, 2018. These fees constitute an up-front interest charge on the debt to help cover administration costs.

Federal Loan Rate Increases for the 2018-2019 School Year

Undergraduate Federal Loans both subsidized and unsubsidized, will rise from 4.45% to 5.05%, an increase of 0.6 percentage points starting July 1.

Graduate Federal Direct Loans will rise from 6% to 6.60%, an overall 10% increase.

PLUS Loans used by both graduate and undergraduate students will increase from 7% to 7.60%, for a total increase of 8.6%.

An Example of the Impact of the Higher Interest Rate:

A student who borrowed $10,000 during the 2017-2018 school year will pay $12,408 using the standard 10-year repayment plan, at an interest rate of 4.45%.

Under the new higher rate, that same $10,000 in debt for the 2018-2019 school year will cost $12,757 under the same 10-year repayment plan, with a rate of 5.05%. The new debt will cost an additional $349.

If the rates continue to rise, over the course of the four to six years it takes to complete a degree; it could substantially increase the monthly loan repayment along with interest repaid.

Private Loans

Market rate loans could conceivably rise faster than federal loans because they do not have caps to keep the rate low.

Advertised low-interest rate private loans are typically not achievable unless the student has excellent credit and reliable income, which most students do not have in place. Less than five percent of borrowers receive the lowest potential interest rate for private student loans.

Many private loans also feature variable interest rates, which can cost significantly more in a rising interest rate environment. Variable interest rates will continue to rise each year the Federal Reserve raises rates.

How Rising Rates Affect Student Loan Consolidation

In most cases, when you consolidate debt or refinance, you pay the current rate or market price, which is usually the highest rate. Student loans work differently:

The consolidation rate formula uses the average of the interest rates on all consolidated loans, rounded up to the nearest 1/8th of one percent to determine the rate. There is no cap on the interest rate of a direct consolidation loan and it converts all loans to a fixed interest rate for the life of the loan. By taking an average of all the interest rates, you can save money on interest charges through a student loan consolidation, even in a rising rate environment.

What Will the Cost of Debt Be for Student Loans?

Today, student loans are a fixed rate product, with the rate set in the year of distribution. The interest rate then remains the same until payoff. Each year, however, the rate will change based on the market. Over a four to six-year period of borrowing, you can pay a different rate each year.

Since 2013, both direct subsidized and unsubsidized loans have the same interest rate. In the case of a subsidized loan, the federal government pays the interest while you attend as a qualified student, resulting in a 0% interest rate while in school.

Online calculators can help you see the direct effect of rising rates on your student loans.

The true financial impact is less severe than other forms of lending because of regulations stipulating how Congress establishes rates on Federal student loans.

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