(Editor’s note: This article was originally published on Dec. 14, 2016. See this post for updated information on rates for federal student loans issued from July 1, 2018 through June 30, 2019, see: “Why student loan interest rates are headed up in 2018.“)
The Federal Reserve’s recent moves to raise a key short-term interest rate may signal the beginning of the end for the post-recession era of low interest rates.
The latest (March 15, 2017) increase in the federal funds rate was modest — just 0.25 percent, bringing the Fed’s target for the benchmark rate to between 0.75 to 1 percent. But depending on how fast the economy grows, the Fed is expected to continue making similar increases every few months. Fed officials now see the federal funds rate hitting 1.4 percent by the end of this year, 2.1 percent by the end of 2018, and 3.0 percent in 2019.
What do rising interest rates mean for student loan borrowers?
Rates on federal student loans are fixed for life, and private lenders typically offer a choice of fixed-rate or variable-rate loans. So if you’re already paying back fixed-rate loans that carry low rates, you don’t have to worry about today’s Fed decision — your rates are locked in.
For borrowers with variable-rate student loans, those rates are typically tied to one of two benchmarks — the London Interbank Offered Rate (LIBOR) and the prime rate.
The prime rate and LIBOR track the federal funds rate pretty closely, so any Fed move to hike short-term rates is likely to translate into rate increases on variable-rate student loans. Borrowers with variable-rate loans — and borrowers who are paying high rates on fixed-rate loans — can look into refinancing options, but there’s no reason to panic. Investors expect the Fed to be cautious about how quickly it increases short-term rates.
You can use Credible.com to see rates you’ll qualify for with multiple lenders who offer student loan refinancing. Our process takes about 2 minutes, won’t affect your credit score, and you don’t have to share your personal information with lenders until you’re ready to pick a refinancing option that’s right for you.
Federal student loan rates
Although rates on federal loans are fixed for life, rates for new borrowers are recalibrated annually. There’s a good chance that rates for students taking out federal loans to attend college in the fall of 2017 will be higher than they are today.
That’s because rates on government student loans are indexed to yields on 10-year Treasury notes. To determine rates on new federal loans for undergraduates, the Department of Education adds 2.05 percentage points to yields on 10-year Treasury notes auctioned each May. The add-on for federal direct loans for graduate school students is 3.6 percentage points, while rates for PLUS loans are equal to the yields on 10-year Treasury note plus an add-on of 4.60 percentage points.
Interest rates for new federal student loans made from July 1, 2016 to June 30, 2017
|Loan type||Borrower type||10-year Treasury note||Add-on||Fixed interest rate|
|Direct subsidized loans||Undergraduate||1.71%||2.05%||3.76%|
|Direct unsubsidized loans||Undergraduate||1.71%||2.05%||3.76%|
|Direct unsubsidized loans||Graduate and professional students||1.71%||3.6%||5.31%|
|Direct PLUS Loans||Parents of dependent undergraduate students and graduate and professional students||1.71%||4.6%||6.31%|
Source: U.S. Department of Education
Since the election, expectations that the Trump administration will have to borrow to boost spending on infrastructure while cutting taxes have pushed rates on 10-year T-notes up by about eight-tenths of a percent, to around 2.5 percent. If that’s where they are in May, rates on government student loans will go up by the same amount.
Projected impact of ‘Trump premium’ on rates for new federal student loans
|Loan type||Borrower type||10-year Treasury note (projected, May 2017)||Add-on||Projected loan rates July 1, 2017|
|Direct subsidized loans||Undergraduate||2.5%||2.05%||4.55%|
|Direct unsubsidized loans||Undergraduate||2.5%||2.05%||4.55%|
|Direct unsubsidized loans||Graduate and professional students||2.5%||3.6%||6.1%|
|Direct PLUS Loans||Parents of dependent undergraduate students and graduate and professional students||2.5%||4.6%||7.1%|
Projected rates for new government student loans issued from July 1, 2017 to June 30, 2018, if 10-year Treasury notes are 2.5 percent in May 2017.
But trying to predict where rates on government student loans will be for students headed to college in the fall of 2017 is more than a little dicey.
Keep in mind that at this time a year ago, the Fed was also expecting the economy to heat up, and increased its target for the federal funds rate by 25 basis points. It was the first time in the Fed had raised rates in nine years, having brought its target for the federal funds rate down to 0 percent during the financial crisis and recession that followed.
But the economy did not grow as quickly as anticipated this year, and long-term interest rates came down. By the time of the crucial May auction, yields on 10-year Treasurys had come down by more than half a percentage point from the previous auction. So rates on government student loans came down by the same amount.
That’s right: The Fed raised rates in December, 2015, and rates on government student loans came down on July 1, 2016.
If president-elect Trump’s stimulus plans fizzle or there are other unexpected bumps on the road to economic recovery, it’s unlikely that rates on federal student loans will fall again, but they may not go up, either.
Private student loan rates
Rates on private student loans are market-based, but changes in short-term and long-term interest rates can affect lenders’ cost of funding. The increase in long-term rates could affect rates on fixed-rate private student loans (and student loan refinancing). Increasing short-term rates can affect the initial rate on variable-rate private student loans.
Borrowers who use Credible to refinance into shorter-term loans reduce their rates by 1.7 percentage points and can expect to save $18,668 over the life of their new loan, on average. So lenders who offer student loan refinancing would have to raise their rates by quite a bit before borrowers saw those potential savings disappear.
For students who are still in school, rates on private student loans can be competitive with rates on costlier government PLUS loans. If rates on private loans and government loans go up in tandem, that’s likely to still be the case.
For more details about how the Credible.com marketplace works, see, “How Credible matches you with lenders.”