Rapidly rising interest rates are hitting consumers at every turn — and from July 1, those borrowing for college will also feel more pain.
Prepare for a significant rate hike on new federal student loans.
Much of the focus on student loan debt lately has been around the buzz that President Joe Biden may be on the verge of making a decision to forgive at least $10,000 in federal student loan debt, what some speculate could apply to borrowers earning less than $150,000 or $300,000 for married couples.
On top of that, millions of student borrowers have been able to avoid making payments for nearly 2.5 years under pandemic-related relief programs. Unless another extension is in the works, their payments are expected to resume in September.
For those still in college, however, the higher interest rates that hit this summer can’t be easily ignored.
The fixed interest rate on federal student loans will rise to 4.99% for undergraduate loans, from 3.73% last year. The new higher rate applies to direct federal Stafford loans for undergraduates issued July 1 through June 30, 2023.
Rates have nearly doubled in the past two years as the federal fixed rate for undergraduate loans fell to 2.75% for the 2020-21 academic year.
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The 4.99% rate brings borrowers closer to the 5.04% rate in the 2018-2019 school year.
It’s important to note that you won’t pay higher rates on money you’ve already borrowed through federal student loans. Lower rates for those who borrowed earlier are locked in.
The cheapest way to borrow for college is for the undergraduate student to first borrow as much money as possible through federal student loans. The undergraduate qualifies for the lowest rates.
After that, rates only go up.
What will parents and graduate students pay?
Parents and graduate students who borrow for college usually pay even higher rates and can expect to see their new rates climb much higher as well.
The new fixed rate will be 6.54% for direct federal Stafford loans for graduates, up from 5.28% for the previous academic year.
The fixed rate for Direct PLUS loans, which can be taken out by parents and graduate or professional students, will increase to 7.54%, from 6.28% the previous academic year. It had been 5.3% for the 2020-21 academic year.
PLUS loans come with a fixed rate for the full term of the loan. Not everyone is eligible for a PLUS loan. A credit check is required. If you have what the Department of Education defines as an “adverse credit history,” you may not qualify unless you meet other requirements. Adverse history includes “accounts with a total balance greater than $2,085 that are 90 days or more past due as of the credit report date” and other factors.
But it’s important to note that Parent PLUS loan rates are not risk-based and everyone will pay a fixed rate of 7.54% for PLUS loans taken out July 1 through June 30, 2023.
Difficult to play rate hikes
You might think there might be a way to borrow more money now if rates go up on July 1 and we have about a month left. But the strategy will not work.
College loan expert Mark Kantrowitz says new high school graduates and their parents can’t rush to take out loans until July 1 to secure lower rates.
“You must be enrolled in college at least half-time at the time of borrowing to borrow student loans,” he said.
“A student who will be enrolled in the fall is not enrolled now,” Kantrowitz said. Therefore, the student would not be eligible to borrow student loans now at this lower rate.
Why the big price hike?
Student loan rates – along with other interest rates – are rising as inflation soars.
The average rate for a 30-year fixed mortgage is 5.27%, up from 3.16% a year ago, according to Bankrate.com.
The average rate for a new car loan over 5 years is 4.61% today compared to 4.12% a year ago.
Federal student loans are pegged to yields from the last 10-year Treasury bond auction in May. The Fed made it clear that it would raise short-term rates to cool the scorching inflation numbers and that swayed the Treasury market.
The consumer price index rose 8.3% over the past 12 months to April. May data will be released on June 10.
Doesn’t everyone pay 0% now anyway?
At the start of the COVID-19 pandemic in March 2020, the federal government provided substantial financial assistance to approximately 20 million college borrowers with federal student loans. Payments were suspended, a 0% rate was applied on outstanding balances and collections were stopped on defaulted loans.
Nearly 60% of college borrowers — or 11.5 million borrowers — with federal student loan debt who qualified for the pandemic freeze made no payments on their student loans from August 2020 to December 2021, according to data published in a May 27 report by the Federal Reserve Board of Governors.
Eliminating the student loan bill from their monthly budgets has helped many people cover other expenses and even reduce other debts, such as credit card debt. The average monthly payment was $260, according to the Fed report.
“Some of these borrowers may not be ready to resume payments once the forbearance expires,” the Fed report said.
The moratorium, which has been extended several times, is set to end on August 31. Reimbursement is expected to resume in September unless another extension takes place, which some say is possible.
“It seems likely there will be a seventh extension, because it would be political suicide for Democrats to start paying back two months before an election,” Kantrowitz said.
Kantrowitz noted that Biden has already canceled more than $18 billion in federal student loans under targeted initiatives involving about 1 million borrowers under existing programs already authorized by Congress.
At the start of June, it was still unclear what kind of additional loan forgiveness might be coming.
How Fed Rate Hikes Do and Don’t Affect Student Loans
The good news for college juniors or seniors is that they have locked in decent rates on past loans.
Federal student loans issued in recent years will not be affected by the student loan rate increase in July or the Fed’s rate hikes in 2022.
But a small group of people who borrowed before 2006 have variable-rate federal student loans that aren’t fixed. Changes to the Fed’s benchmark rate can affect variable interest rates, according to Robert Humann, chief revenue officer of Credible.com.
And private student loan rates are often not fixed rates and can be directly impacted by future Fed rate hikes.
“Several factors, including a lender’s cost of capital and appetite for growth, affect rates, so borrowers should expect private student loans to be slightly affected by rising rates” , Humann said in a statement to the Free Press.
He noted that some borrowers with good credit — scores of 720 or higher — were able to lock in rates of 5.56% on 10-year fixed private student loans during the week of May 9. That was down from 6.03% the previous week.
The 10-year fixed rates for private student loans were around 6% and the variable rate for 5-year private student loans was around 4.33% as of the week of May 23, the most recent Credible data available.
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“Absolutely avoid variable-rate private student loans because interest rates have no choice but to rise,” says Kantrowitz.
The temptation might be to find a low rate of around 1% or 3% for a variable student loan, but it is essential to remember that the rate is not fixed for the duration of the loan. A variable rate could rise if rates continue to rise.
“A variable rate is only an option if the borrower is going to pay off all of the debt before interest rates rise too much,” Kantrowitz said.
And many won’t qualify for those ultra-low rates.
Borrowers should shop around and compare the rates offered to them based on their credit.
You also need to know if you need a co-signer like a parent to get a better rate. On co-signed loans, the co-signer’s credit score is used if it is higher than the borrower’s score.
Private student loans often take your credit score into account, and rates vary widely based on your credit history. Some variable private student loan rates can vary from around 1% to almost 12%, depending on creditworthiness.