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Students taking out federal student loans this fall will pay the lowest interest rates in history, thanks to a “flight to safety” by investors who have flocked to government bonds during the coronavirus pandemic.

Rates on federal student loans taken out during the 2020-21 academic year will be 1.78 percentage points lower than last year, potentially saving borrowers more than $9 billion in interest charges over 10 years.

The lower rates scheduled to take effect July 1 for new federal student loans are the result of falling bond yields that have allowed the government to borrow money more cheaply. Under a rate-setting formula in effect since 2013, those savings will be passed along to families.

The average savings on federal student loans taken out during the 2020-21 academic year will range from $669 for undergraduates to $2,797 for graduate students taking out federal PLUS loans at higher rates.

New federal student loan rates for 2020-2021

Rates for new borrowers are adjusted once a year, using a formula that ties interest rates on federal student loans to yields on 10-year Treasury notes auctioned each May.

Based on the result of today’s Treasury auction, the new rates scheduled to take effect on July 1 for federal student loans taken out during the 2020-21 academic year will be:

  • Undergraduates: 2.75% (down from the 4.53% rate in effect during 2019-20)
  • Graduate students: 4.3% (down from the old rate of 6.08%)
  • Grad and parent PLUS loans: 5.3% (down from 7.08%)

Those are record lows for all three types of federal student loans.

How much the average student will save

The average student could save $669 to $2,797 in interest charges on loans taken out during the 2020-2021 academic year and repaid over 10 years. This is the potential savings for one year of borrowing, spread out over 10 years.

Graduate students and parents stand to save the most, because they’re charged higher rates and take out bigger loans.

  • Undergraduates: $669 in interest charges on loans they take out in 2020-21, based on average annual borrowing of $6,660 paid back at 2.75% interest instead of 4.53%
  • Parents taking out PLUS loans: $1,856 based on $17,220 in average annual borrowing paid back at 5.3% interest instead of 7.08%
  • Graduate students: $2,020 in interest charges on unsubsidized direct loans, on average, based on annual borrowing of $19,250 paid back at 4.3% instead of 6.08%
  • Graduate students taking out PLUS loans: $2,797, based on average annual borrowing of $25,950 paid back at 5.3% interest instead of 7.08%

$9.65 billion in total savings projected

While undergraduates borrow less and pay lower interest rates, they also represent the largest group of borrowers. So undergraduates will claim the largest share of an estimated $9.65 billion in savings.

All told, lower rates on federal student loans could save:

  • Undergraduates: $4.15 billion in interest. About 6.2 million undergraduates take out $41.32 billion in subsidized and unsubsidized federal direct student loans each year, according to the latest numbers from the College Board.
  • Graduate students: $4.11 billion in interest. Roughly 1.45 million graduate students rely on $27.88B in unsubsidized direct student loans each year, and 422,000 graduate students take out $10.96B in PLUS loans.
  • Parents taking out PLUS loans: $1.39 billion. About 749,000 families take out $12.9B in parent PLUS loans each year.

These are conservative savings estimates since they assume that borrowers will begin repaying their loans immediately on the standard 10-year repayment plan.

In practice, most students don’t make payments while they’re still in school, and interest that accrues on unsubsidized loans is capitalized after graduation. Also, it’s increasingly common for borrowers to take as long as 20 or 25 years to repay their debt in income-driven repayment plans, which can increase the total amount of interest paid (but may also provide loan forgiveness).

How rates on federal student loans are set

Once you take out a federal student loan, the interest rate is fixed for life. But rates offered to new borrowers are adjusted annually. So students have different interest rates on the federal student loans they take out each year they’re in school.

To take into account changes in the government’s cost of borrowing, Congress has mandated that rates on federal student loans be tied to an auction of 10-year Treasury notes that’s held each May. As the government’s cost of borrowing rises or falls, so do rates offered to new borrowers taking out federal student loans.

In today’s auction of 10-year Treasury notes, the high yield of 0.70% was 1.78 percentage points lower than last year’s, resulting in an across-the-board reduction in student loan rates by the same amount, effective July 1, 2020.

The Department of Education uses these formulas to set rates:

  • Loans to undergraduates: 10-year Treasury yield plus add-on of 2.05 percentage points
  • Direct loans to graduate students: 10-year Treasury yield plus 3.6 percentage points
  • Parent and grad PLUS loans: 10-year Treasury yield plus 4.6 percentage points

Regardless of how high Treasury yields go, Congress has set upper limits capping student loan interest rates at 8.25% for undergraduate loans, 9.5% for graduate loans, and 10.5% for PLUS loans.

While current procedures for setting student loan interest rates have been in place for nearly a decade, Congress could always pass new legislation that provides additional relief to borrowers.

The CARES Act, signed into law on March 27, temporarily reduced interest rates on federal student loans owned by the government to 0% through Sept. 30, for example.

Since then, a number of borrower relief proposals have been put forward. In April, groups representing colleges and students asked lawmakers to:

  • Extend the 0% interest rate reduction for existing loans through June 30, 2021
  • Set the interest rate on all new federal student loans issued before that date at 1.5%

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About the author
Matt Carter
Matt Carter

Matt Carter is an expert on student loans. Analysis pieces he’s contributed to have been featured by CNBC, CNN Money, USA Today, The New York Times, The Wall Street Journal and The Washington Post.

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