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Students attending college this fall will pay lower interest rates when they take out federal student loans, putting them on track to save at least $2.9 billion in interest.
Rates on federal student loans to new borrowers are set to drop by five-tenths of a percentage point on July 1, 2019. The first rate reduction for federal student loans in three years is the result of falling bond yields that allow the government to borrow money more cheaply.
The average savings on federal student loans taken out during the 2019-2020 academic year will range from $199 for undergraduates to $805 for graduate students taking out PLUS loans.
New federal student loan rates for 2019-2020
The new rates on federal student loans, effective from July 1, 2019, through June 30, 2020, will be:
- Undergraduates: 4.53% (down 10% from the 5.05% rate in effect during 2018-19)
- Graduate students: 6.08% (down 8% from the old rate of 6.6%)
- Grad and parent PLUS loans: 7.08% (down 7% from the previous rate of 7.6%)
How much the average student will save
The savings generated by these lower rates will be most pronounced for graduate students and parents. That’s because grad students and parents not only pay higher rates, they also take out bigger loans.
The estimated average savings for each group of borrowers will be:
- Undergraduates: $199 in interest charges on loans they take out in 2019-20, based on average annual borrowing of $6,570.
- Parents taking out PLUS loans: $534 based on $16,450 in average annual borrowing.
- Graduate students: $596 in interest charges on unsubsidized direct loans, on average, based on annual borrowing of $18,860.
- Graduate students taking out PLUS loans: $805 based on average annual borrowing of $24,810.
Undergrads will claim biggest slice of $2.9 billion savings pie
Although undergraduates take out smaller loans and pay lower interest rates, they represent the largest group of borrowers. That means they’ll claim the largest share of an estimated $2.9 billion in savings.
All told, lower rates on federal student loans could save:
- Undergraduates: $1.3 billion in interest. About 6.5 million undergraduates take out federal student loans each year, according to the latest numbers from the College Board.
- Graduate students: $1.2 billion in interest. Roughly 1.4 million graduate students rely on unsubsidized direct student loans each year, and 416,000 graduate students take out PLUS loans.
- Parents taking out PLUS loans: $416 million. About 779,000 families take out 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 a growing number of borrowers are taking up to 20 or 25 years to repay their debt in income-driven repayment plans.
Why federal student loan interest rates are falling
Once you take out a federal student loan, the interest rate is fixed for life. But rates offered to new borrowers are adjusted annually. That means students will typically have different rates on the federal student loans they take out each year they’re in school.
It’s ultimately up to Congress to decide how much interest to charge on federal student loans. But in an attempt to remove politics from the equation, lawmakers have tied rates on student loans to the government’s cost of borrowing.
How rates are set
Here’s how the system that’s been in place since 2013 works: Whatever yield investors are willing to accept in an auction of 10-year Treasury notes that’s held in May serves as the benchmark for new student loan interest rates that take effect in July. When the government’s cost of borrowing goes up or down, so do rates on federal student loans (whether the government makes or loses money on student loans is fiercely debated — the answer depends on the accounting methods used).
In today’s auction of 10-year Treasury notes, the high yield of 2.48% was 0.52 percentage points lower than last year’s auction, resulting in an across-the-board reduction in student loan rates by the same amount, effective July 1, 2019.
The Department of Education uses the following 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
No matter how high Treasury yields go, Congress has set upper limits capping rates at 8.25 percent for undergraduate loans, 9.5 percent for graduate loans, and 10.5 percent for PLUS loans.
It might seem odd that federal student loan rates are falling, even though the Federal Reserve hiked short-term interest rates four times last year.
But the Fed has less influence over long-term rates, which are driven by market demand for investments like Treasury notes and mortgage-backed securities. When investors sense danger in riskier assets like stocks, they buy bonds, which pushes long-term rates down.
The Fed has hiked the short-term federal funds rate nine times since December 2015, by a total of 2.25 percentage points. But as of May 2019, 10-year Treasury yields and mortgage rates had posted much smaller gains, at times moving in the opposite direction.
What about private student loans?
Because they’re typically paid back over 10 years or more, initial rates on private student loans tend to track changes in long-term rates more closely than Fed rate hikes. So rates for private student loans and student loan refinancing have remained competitive with federal student loans, even as short-term interest rates have gone up.
As of May 8, 2019, lenders competing to refinance student loans on the Credible marketplace offered fixed rates as low as 3.39% and variable rates starting at 2.80%. Lenders providing funding to current students offered fixed-rate loans starting at 4.50%, and variable-rate loans starting at 4.07%.
If you choose a variable-rate private student loan, the initial rate can go up or down with an index like LIBOR or the prime rate, which tend to track the Fed’s moves closely.
Not everyone will qualify for such low rates. Unlike the government, private lenders evaluate each borrower’s ability to repay before deciding whether to offer them a loan and at what interest rate.
The higher your credit score, the lower the rate you’ll be offered. But every lender has its own approach to evaluating borrowers, so it’s important to request rates from multiple lenders.
Most students who are going to college straight out of high school won’t have enough credit history or income to qualify on their own for a private student loan. They’ll need a parent, friend, or other relative to cosign their loan. But getting a cosigner can help borrowers get lower rates.
Decline in student loan borrowing
Annual student loan borrowing peaked in 2010-11 and has declined for seven years in a row, to $105.5 billion in 2017-18.
Student loan limits on federal loans haven’t increased in more than a decade, leaving more families turning to federal PLUS loans. Even after adjusting for inflation, PLUS loan borrowing has grown by 17% in the last seven years, to $23.1 billion. Private student lending has picked up even faster, growing by 36% to $11.6 billion.
Grad students and parents taking out federal PLUS loans pay higher rates and fees than undergraduates, making private student loans worth investigating.
At 7.08%, PLUS loans are the costliest federal student loan. You also have to factor in the 4.25% upfront fee on PLUS loans, which can have the same effect as adding another full percentage point to the annual percentage rate (APR).
Once you’ve checked to see what rates you can qualify for with private lenders, it’s also a good idea to compare other loan features like repayment options. Federal student loans offer borrower protections like access to income-driven repayment plans and the potential to qualify for loan forgiveness after 10, 20, or 25 years of repayment.
Credible is a marketplace that lets borrowers compare personalized student loan rates from multiple lenders by filling out a single form. Our process only takes 3 minutes and doesn’t affect your credit score. For more tips on financing your degree, see our guide on How to Pay for College.