How to Manage Rising Student Loan Rates
Interest rates for federal and private student loans are set to increase
Like any other loan, your interest rate is important for determining the true cost of financing your education. Student loan rates on federal loans are set to rise for borrowers taking on new loans for the 2018-19 academic year. At the same time, the Federal Reserve's recent increases in the federal funds rate are poised to impact some private loan borrowers.
If you have education debt, or you'll soon be taking on loans to fund a college degree, it's important to understand the impact of rising student loan rates.
Federal Student Loan Rates Spike
Beginning with loans disbursed July 1, 2018, federal undergraduate student loan rates are set to rise from 4.45% to 5.05%, representing a 13% increase overall. Rates for graduate student loans will climb from 6% to 6.60%—an increase of 10%. Finally, rates for PLUS loans—available to both graduate students and parents of undergraduates—will rise from 7% to 7.6%, marking an 8.6% increase.
These rates apply to new loans disbursed for the 2018-19 academic year. The sharp uptick in rates can be attributed to an increase in the 10-year Treasury note rate, which surpassed 3% in April 2018. Federal student loan rates are indexed to this rate; each year in May, 10-year Treasury notes are auctioned, establishing student loan rates for the following year.
The change doesn't affect existing loans, fortunately. But, it means a more expensive student loan repayment for borrowers taking out loans after July 1st.
The chart below illustrates the changing student loan rates from 2006 through today.
Variable Private Student Loan Rates May Follow Suit
Private student loans can be used to fill the gap not covered by federal student loans. These loans may have fixed or variable rates. While variable-rate loans can offer savings to borrowers if fixed rates remain higher, they can become more costly as interest rates rise.
Variable-rate student loans are tied to an index rate, such as the LIBOR or the Prime Index. Both of these rates can be influenced by the federal funds rate. When the Fed raises the federal funds rate, the associated index rates may also follow suit. The end result is a higher rate for private student loan borrowers with variable rate loans.
The Fed has increased the federal funds rate seven times since December 2015, most recently in June 2018. The current rate forecast calls for two additional rate hikes in 2018, with the possibility of two to four more in 2019. That means that both current and new private student loan borrowers may be paying more for variable rate loans sooner, rather than later.
How to Adjust Financially When Student Loan Rates Rise
Rising student loan rates can pack a punch to your wallet but there are options for making education debt more manageable.
In the case of federal student loans, consolidation allows borrowers to combine their loans into a single loan, with a single monthly payment. Your student loan rate on the new loan is the average of each loan's individual rate. This doesn't allow you to avoid a higher rate on new loans; however, consolidating could make your monthly payment more manageable and the interest accumulation more predictable.
Another possibility is public service loan forgiveness. This is available to borrowers who plan a career in public service after graduation. To be eligible, you must commit to working in a public service field and making 120 payments to your loans. After that point, the remainder of your loans can be forgiven. Enrolling in an income-driven repayment plan during that time allows you to pay less each month towards your loans, though it won't affect your interest rate.
For borrowers with variable rate private student loans, refinancing into a fixed-rate loan may hold appeal. Locking in a fixed rate insulates you against further rate hikes.
Refinancing private student loans is similar to refinancing any other loan. The lender reviews your credit score, income, and financial background to determine if you qualify. (If you don't have a high enough credit score, you may need a cosigner to refinance.) Once you're approved, you take out a new loan at a fixed rate and the old one is paid off.
It's possible to refinance federal and private loans together, but there are some things to be aware of first. Refinancing a federal loan into a private loan doesn't guarantee a lower fixed rate. And, more importantly, you lose certain protections available only to federal loans, including grace periods, deferment and forbearance. You can't undo a federal loan refinance so it's important to weigh the potential interest rate benefits against what you might be losing.
Planning for Rising Student Loan Rates In Your Budget
If you opt not to refinance or consolidate your loans, it's important to review your budget to account for the possibility of higher monthly payments.
If a higher rate on new federal loans, for example, would stretch you thin financially, you may need to consider an income-driven repayment plan temporarily. Just remember that if you stay on an income-driven plan with lower payments for the long term, you could end up paying significantly more in interest overall.
Similarly, consider how an adjustment in your variable rate would affect your private student loan payments. Private lenders don't always offer income-driven repayment or hardship programs; before sticking with a variable rate, be sure to run the numbers to make sure your new payment will still be affordable.