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In May, 2022, the Federal Reserve announced its second national rate hike of the year, a move that caused an almost immediate uptick in student loan interest rates. So far, the impact has been modest, but with several more rate increases likely on the horizon, some student loan borrowers are worried.
Higher rates burden students looking to borrow for the upcoming academic year, but they can also affect those with existing student loan debt. If you’re still paying off the cost of your higher education, increased rates could mean increased monthly payments. That’s especially true if you have variable-rate student loans.
Here’s what you need to know about changing interest rates—and how to mitigate rising costs.
Why do interest rates change?
When national interest rates spike or plummet, the Federal Reserve often has something to do with it. The Reserve is the federal government’s financial arm. It’s in charge of monitoring and regulating the U.S. economy. It’s also in charge of setting the federal funds rate, the target rate the government recommends all lenders and borrowers strive for.
Sometimes, the Reserve lowers the federal funds rate by a few percentage points to encourage borrowing and stimulate the economy, like it did during the pandemic. More recently, however, the Reserve has been doing the opposite: raising rates to try to stem inflation.
Do student loan interest rates change? What are they now?
Variable interest rates are exactly what they sound like: They vary, or change, according to national trends. And though a student loan’s annual percentage rate (APR) isn’t based directly on the federal funds rate, it’s still pretty connected. That’s because student loan servicers set their interest rates based on a “reference rate” – a sort of national average rate that’s published regularly by a big national bank. In the case of Earnest, and many other student loan servicers, this reference rate is the “Secured Overnight Financing Rate” (SOFR), which is published monthly by the Federal Reserve Bank of New York. Because it’s a national average, it tends to go up when the federal funds rate goes up, and down when the federal funds rate goes down.
In short, when the federal funds rate goes up, SOFR goes up. When SOFR goes up, so do the interest rates on your variable-rate student loans. (You can see rates for the current year here.)
How often do rates change for federal student loans?
Federal student loans have fixed interest rates, which means they won’t vary over the life of the loan. However, the interest rates offered to new borrowers changes on an annual basis.
Federal student loan interest rates — including those for Parent PLUS and Grad PLUS loans — are set by Congress. These rates are based on the 10-Year Treasury Note auction, which happens each spring. Rates are announced for the upcoming school year shortly after the auction, then implemented for new loans starting July 1.
How often do rates change for private student loans?
Private student loan servicers aren’t beholden to rigidly set annual rates like federal servicers are. Instead, private lenders more closely follow national trends, often updating their rates on a monthly basis to reflect those trends. If you have variable-rate loans, your bill will likely vary from month to month as well.
What happens to my loan payment when rates change?
Your student loan payments may or may not change as national interest rates trend up or down. It all depends on the type of loan you have — and on your payment habits.
If you have a fixed-rate loan…
With a fixed-rate loan, your interest rate is locked in for the entire life of the loan. That means you don’t have to worry about your rates changing on you, no matter what’s going on with the national economy.
All federal student loans have fixed rates. Some private loan servicers, including Earnest, also offer fixed-rate options. If you’re not sure what you have, log in to your student loan account to check the terms of your loan.
If you have a variable-rate loan…
Variable rates are only offered by private student loan servicers. Variable-rate loans are often cheaper than fixed-rate loans when you first apply for them, but they essentially put you at the mercy of the U.S. economy. As national interest rates tick up or down, so will the interest rates on your student loan. They may change monthly, quarterly, or annually, depending on your loan servicer.
As for the cost of your actual student loan payment? It depends. That’s because your minimum payment and your monthly payment are not always the same thing.
Each loan has a minimum due amount. This is the minimum monthly amount that you’re required to pay to remain in good standing, and it’s precise down to the penny. If you’re paying the exact minimum due every month — for example, $544.96 — you will see your payment increase or decrease to reflect a new minimum on your variable-rate loan.
However, if you’re in the habit of paying more than your minimum due (a tactic you should use if you’re able to, since it will pay down your loan principal faster and decrease the interest owed each month), your actual payment may not increase at all.
For example, if you were paying $600 per month and your minimum due increased from $544.96 to $588.32, you could continue to pay $600 each month. The only thing that would change is the amount of your payment that’s applied to interest and the amount that is applied to your principal.
With your Earnest loan, you can always view your current minimum due or adjust your payments.
How do rate changes affect getting a new loan?
Increased rates make borrowing more expensive, but there are a few tactics for mitigating the extra burden.
Applying for new federal student loans
If you’re looking to take out new federal student loans, there’s not much you can do to get ahead of the rate hike. Still, most experts recommend maxing out federal loans before you max out private loans, especially now that the Biden Administration has put a pause on student loan interest during the pandemic.
Federal loans also offer forbearance and deferment, income-based repayment options, and other major perks. And unlike private loan servicers, the U.S. Department of Education doesn’t look at your credit score at the time of origination, which means there won’t be a penalty for less-than-stellar credit on top of the higher set interest rate.
Applying for new private student loans
If you’re in the process of refinancing a loan1 or planning to get a new private loan,2 you can choose between variable and fixed-rate loans. Choosing wisely can help you save money when rates are volatile.
Here are some general guidelines to consider if you’re taking a new private loan or refinancing:
Variable rates are better when:
- Your budget can handle an increased minimum payment.
- You have a shorter loan repayment term, which limits the chances for rates to change.
- You believe interest rates will decrease or stay flat in the near future.
Fixed rates are better when:
- You have a longer loan term, and you don’t want to be affected by moving rates.
- You don’t want your minimum payment to increase.
- You believe rates will increase in the future and want to lock in a lower interest rate now.
Can I switch from a variable-rate loan to a fixed-rate loan?
Student loan refinancing3 is a method for combining existing loans into a single, new loan. When you refinance through a private lender, you get a new interest rate, loan term, and repayment plan. So, yes — if you’re worried about your variable interest rates, you can switch to a fixed interest rate by refinancing your private student loans. (Refinancing also has other benefits, like allowing you to release a cosigner.)
Keep in mind that your new fixed rate may be higher than your old rates at first. The benefit is that it won’t go up if the Federal Reserve implements another rate hike (or several). That will save you money over the long term if rates continue to increase.
Can I refinance my federal student loans to get a lower rate?
If you have federal student loans, these already have fixed interest rates. You can simplify your bill and get a new repayment term via federal student loan refinancing (also called consolidation) through the Department of Education. But because federal loans aren’t based on your credit score or financial standing, federal consolidation just results in an average of your previous interest rates — not a lower rate.
You can, however, secure a new interest rate if you refinance your federal loans through a private lender. This is only beneficial if you have good to excellent credit, and if rates have dropped significantly since you first took out your loans. Do some math (or use a refinance calculator) to make sure getting a new rate will save you more money than current federal relief programs will. Finally, you should be prepared to give up protections like the generous forbearance and deferment options — and potential for loan forgiveness — that come with federal loans.4
What will happen with interest rates in the future?
First, a big disclaimer: It’s impossible to know for sure what rates are going to do. There’s no limit to how much the reference rate can rise or fall in any one year. However, some loan servicers, like Earnest, provide a little built-in protection by setting a maximum APR.
Earnest guarantees that your interest rate will never exceed 8.95% for loan terms 10 years5 or less. If your student loan repayment term is between 10 and 15 years, your interest rate is capped at 9.95%. For loan terms over 15 years, your maximum interest rate is 11.95%. Federal rates also have caps: 8.25% for undergraduate student loans, 9.5% for graduate students, and 10.5% for parental loans.
Right now, the Federal Reserve expects to raise rates a few more times over the next year or so. However, some economists predict that President Biden will extend the pause on federal interest rates that was implemented during the pandemic, or even expand federal student loan forgiveness programs. That means that if you plan to take out federal loans, it’s possible that you won’t be affected by rising interest rates for some time yet.
See how much you could save with Earnest
Federal Reserve rate changes have ripple effects that reverberate throughout the U.S. economy. These affect all kinds of financial markers—including student loan interest rates. The best way to stay ahead of rising rates is to make smart decisions when it comes to taking out new loans, and to carefully consider your refinancing options for existing private loans.
With Earnest, you can get a free estimate using their online rate calculator or refinance calculator—neither of which will affect your credit score. Earnest also offers other benefits, like fee-free origination, customized repayment terms, and deferment options to help provide peace of mind amid unexpected rate hikes. Check it out today, and see how much you could save.
Disclaimer: This blog post provides personal finance educational information, and it is not intended to provide legal, financial, or tax advice.
1 Loan Eligibility criteria: Your debt is from paying for education at a Title IV accredited school. The debt is from your education or your child’s. The debt you’re refinancing is for a completed degree or one that will be completed at the end of this semester. You are currently the primary borrower on the student loans you would like to refinance, and you will remain the primary borrower after refinancing. You must reside in the District of Columbia or one of the 48 states Earnest Operations LLC is authorized to lend in (all but Kentucky and Nevada). This is strictly a student loan refinance product. There is no opportunity to borrow more than your outstanding qualifying student loan amount. You must be the age of majority in your state or older at the time you apply, as well as be a United States citizen or Permanent Resident Alien without conditions. Refinancing is subject to credit qualifications. Please note, we are not able to offer variable rate loans in AK, IL, MN, NH, OH, TN, and TX.
2 Loan Eligibility criteria: Eligible students must: 1) For college Freshmen, Sophomores and Juniors, attend, or be enrolled to attend, a Title IV school full-time. For college Seniors and Graduate students, attend, or be enrolled to attend, a Title IV school at least half-time; and 2) be pursuing a Bachelor’s or Graduate degree. Earnest private student loans are subject to credit qualification, completion of a loan application, verification of application information, self-certification of loan amount, and school certification.
3 Choosing to refinance to a longer term may lower your monthly payment, but increase the amount of interest you may pay. Choosing to refinance to a shorter term may increase your monthly payment, but lower the amount of interest you may pay. Review your loan documentation for total cost of your refinanced loan.
4 You may lose benefits associated with your underlying federal and/or private loans if you refinance such as federal Income-driven Repayment Plans, Economic Hardship Deferment, Public Service Loan Forgiveness, or other deferment and forbearance options. If you file for bankruptcy, you may still be required to pay back this loan.
5 Earnest’s Loan Cost Examples: These examples provide estimates based on payments beginning immediately upon loan disbursement. Variable APR: A $10,000 loan with a 20-year term (240 monthly payments of $XX) and a X.XX% APR would result in a total estimated payment amount of $XX,XXX.XX. For a variable loan, after your starting rate is set, your rate will then vary with the market. Fixed APR: A $10,000 loan with a 20-year term (240 monthly payments of $XX) and a X.XX% APR would result in a total estimated payment amount of $XX,XXX.XX. Your actual repayment terms may vary.
Responsible borrowing tip: Explore all scholarship, grant and federal options before applying for a private loan.
Earnest Loans are made by Earnest Operations LLC or One American Bank, Member FDIC. Earnest Operations LLC, NMLS #1204917. 535 Mission St., Suite 1663, San Francisco, CA 94105. California Financing Law License 6054788. Visit www.earnest.com/licenses for a full list of licensed states. For California residents: Loans will be arranged or made pursuant to a California Financing Law License. One American Bank, 515 S. Minnesota Ave, Sioux Falls, SD 57104.
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