How the Rising Interest Rates on Student Loans Affect Young Borrowers

Planning on borrowing money to go to college? Be aware that federal student loan interest rates are going up.

This new interest rate affects loans taken out between July 1, 2018 and June 30, 2019.

What Are Federal Student Loans?

Students looking to finance their education have two main options:

  • Federal loans administered by the government
  • Private loans offered directly by banks and other private lenders, including college and universities themselves

Federal student loans have a few advantages, compared to private student loans. They often have lower interest rates than private loans. Federal student loans also offer fixed interest rates.

This means that the interest rate does not change over the life of the loan.

Interest rates and repayment

Some student loans may offer fixed interest rates. But many private loans come with variable interest rates. This means that your interest can go up over time.

If you have financial need, you can receive a subsidized federal student loan.

With a subsidized loan, the federal government pays the interest on your loan while you are in school. Private student loans do not offer subsidized loan options.

You do not have to pay federal student loans back until after you graduate (or leave your educational institution). Many private student loans require you to make payments while you are still a student.

Once you start making payments, federal student loans offer flexible repayment options.

Many federal loan recipients follow the 10-year standard repayment plan.

You can also choose repayment plans based on your earnings — the more you earn, the more you pay. These types of plans work well if you expect periods of low income after graduation.

You can also consolidate your federal loans to simplify your monthly payments. The federal government even offers loan forgiveness programs for teachers and people who work in public service.

Why Are Federal Student Loan Interest Rates Going Up?

Every spring, the federal government holds a 10-year Treasury Note auction.

That auction determines what’s called the “yield.” This has to do with the amount of money bidders are willing to pay for the 10-year Treasury Notes. When bidders drive up the bidding, they also drive down the yield — and vice versa.

The auction also determines student loan interest rates. These rates are based on the high yield of the 10-year Treasury Note plus a fixed margin.

On May 9, 2018, the auction determined that the group of 10-year Treasury Notes in question would have a high yield of 2.995%. This is higher than 2017’s rate, which was 2.400% — so student loan interest rates went up as well.

What Does This Mean for New Borrowers?

New borrowers should expect to pay higher interest rates on federal student loans.

The U.S. Department of Education released a chart listing the new fixed interest rates for federal student loans, as follows:

Federal Student Loan Interest Rates for 2018-2019

Loan Type 10-Year Treasury Note High Yield Add-On Fixed Interest Rate
Direct Subsidized Loans and Direct Unsubsidized Loans for Undergraduate Students 2.995% 2.05% 5.05%
Direct Unsubsidized Loans for Graduate and Professional Students 2.995% 3.60% 6.60%
Direct PLUS Loans for Parents of Dependent Undergraduate Students and for Graduate or Professional Students 2.995% 4.60% 7.60%

How big of an increase is this? Let’s compare.

Undergraduate students were paying 4.45% interest for direct subsidized and unsubsidized loans.

Graduate students were paying 6.00% interest for direct unsubsidized loans.

Graduate students and parents were paying 7.00% interest for Direct PLUS loans.

How Much Can You Expect Your Monthly Payments to Increase?

Did you take out a student loan after July 1, 2018? You can expect your monthly payments to be roughly 2.8% higher than they would have been compared to the the previous year.

It’s the difference between a $100 monthly payment and a $102.80 monthly payment.

This assumes you’re following the 10-year Standard Repayment Plan. If it takes more or less time to pay off your loan, your monthly payments will go up or down accordingly.

While 2.8% may not sound like much 

What if you already have federal student loans?

The interest rate increase only applies to new federal student loans taken out between July 1, 2018 and June 30, 2019.

Did you take out federal loans before July 1, 2018?

In that case, you will continue paying the fixed interest rate associated with those loans. Their interest rates will not change. If you take out a new federal loan, you will pay the new, higher interest rate.

Does This Interest Rate Affect Private Loans?

The federal student loan interest rate increase only affects federal loans.

It does not affect private student loans, such as bank loans.

Private lenders may elect to raise their interest rates as well, so don’t be surprised if you see private student loan interest rates increase.

If you have private student loans, pay attention to whether your interest rate is fixed or variable.

A fixed interest rate will remain constant over the life of the loan.

A variable interest rate can change over time based on the market.

This means that you could end up paying higher interest rates on a private loan you’ve already taken out. If you do, it’ll be because the private lender raised your interest rate, not because federal lenders increased theirs.

Is There a Limit on How High Federal Student Loan Interest Rates Can Go?

In 2013, Congress passed a law to put a cap on federal student loan interest rates.

Federal student loan interest rates can be no higher than 8.25% for undergraduate loans and 9.2% for graduate loans.

Parents who take out loans on behalf of their children won’t pay interest rates above 10.5%.

Congress passed this law to keep higher education as affordable as possible.

What Can You Do If You Can’t Afford Your Student Loan Payments?

Having trouble with your monthly student loan payments? You have several options:

Refinancing

By switching your student loans to a new lender, you can lower your interest rates and reduce your monthly payment.

Deferment

You can postpone student loan payments until the future. Depending on the type of loan, you might not have to pay interest during your deferment period.

Forbearance

Like deferment, forbearance lets you postpone student loan payments. During forbearance, your loans still earn interest. You can pay that interest during the forbearance period. You can also save the payments until after forbearance ends.

Consolidation

Consolidating your loans lets you make a single monthly payment instead of multiple loan payments. Consolidating your student loans also consolidates their interest rates. This could save you money over time.

Income-based repayment

This federal student loan payment plan lets you make payments based on your income. If you have low income, your monthly payments are lower.

Loan forgiveness programs

Some teachers and public service workers are eligible for federal student loan forgiveness. Take a look at the loan forgiveness programs and see if they are right for you.

Conclusion

Rising student loan interest rates can make it more difficult to pay off your loans.

But the federal student loan interest rate increase won’t affect you unless you take out federal student loans between July 1, 2018 and June 30, 2019.

If you took out federal student loans before July 1, 2018, you will continue to pay the fixed interest rate set at the beginning of your loan.

If you took out private student loans with variable interest rates, your loan rate might change in the future. But it won’t be tied to the federal student loan interest rate increase.

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