Beware, new student loan borrowers: Interest rates are about to jump
With so much talk these days of when or whether President Biden will broadly cancel student debt – and with payments and interest on that debt paused for more than two years – it's easy to forget that the federal student loan system remains unchanged. And one part of that system is about to deliver a shock to many borrowers: Interest rates are going up, likely by quite a bit.
"We're going to get bad news," says Robert Kelchen, an expert on higher education finance at the University of Tennessee, Knoxville.
Interest rates on federal student loans are fixed, like a mortgage. A student who took out a new, undergraduate loan for this school year got a good interest rate: 3.73%. And that loan will remain at that rate for the life of the loan.
The wrinkle, says Kelchen, is that "every year, interest rates reset based on the 10-year Treasury yield, plus some additional amount," a premium added to help cover the government's costs.
That means borrowers who need help next year will have to take out a new loan at a new interest rate. Federal student loan rates change every May, based on the U.S. Treasury Department's auction of 10-year notes, which is set for 1:00 pm ET on Wednesday, May 11.
And that's bad news for borrowers because, this year, as with mortgage rates and virtually everything else, student loan interest rates are sure to rise.
While we don't know exactly how much they'll rise, we can make some educated guesses by applying some basic math, spelled out in federal law, to the current 10-year Treasury rate, 3.06% at the time of writing.
For example, undergrads' current 3.73% interest rate would jump to 5.1%.
What's the difference between 3.73% and 5.1%? On a loan of $5,500 (the max for a first-year, dependent undergrad), a borrower would end up paying $435 more in interest over 10 years.
The change could have an even bigger impact for graduate students and parents, who are allowed to take out larger loans but at higher rates than undergraduate borrowers (not to mention having to pay a larger loan fee upfront as well, 4.2% vs. 1.1%).
Based on the latest 10-year Treasury rate, interest on loans for grad students is likely to jump from the current 5.28% to around 6.66%, and for parent PLUS loans from 6.28% to around 7.66%.
These loans aren't capped like undergraduate loans and are only limited by a school's price tag, which helps explain why the average yearly Parent PLUS loan tops $14,000. What difference would this potential interest rate hike make on that kind of loan?
Over 10 years, a parent would end up paying an extra $1,194 in interest.
The higher rate for parents, combined with larger allowable debt loads and less generous access to income-driven repayment options, has driven many families to financial ruin.
For potential borrowers wondering if they could do better on the private loan market, "just remember, the federal student loan program is in large part making loans without any sort of credit check. Everybody gets the same terms. It's kind of no questions asked," says Jason Delisle, a senior policy fellow at the Urban Institute.
And yes, Delisle says, "the rate is going to be a lot lower than what you would get in the private market for a similar kind of loan – if you could even find something like it."
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