What do interest rate hikes mean for student loans?
College students who plan to take out federal loans to cover their 2023-24 academic year will see those rates edge higher on July 1.
The Federal Reserve boosted short-term interest rates on May 3, the 10th time since the Fed began fighting inflation with rate hikes back in March 2022.
Many consumers and businesses will start to pay more on a variety of loans. The prime rate shot up to 8.25% after the Fed's latest quarter-point hike. And plenty of loans, including credit cards, are likely to follow with rate hikes in the next month or so.
More news on student loan rates ahead
When it comes to federal student loans, though, the connection to the Fed's rate hikes is less direct. Interest rates on federal education loans change each July 1 based on the last 10-year Treasury Note auction in May, which will be May 10.
A possible estimate is that the Federal Direct Stafford Loan for undergraduate students could be around 5.5% when the rate is announced this summer, according to Mark Kantrowitz, a student loan expert who is the author of "How to Appeal for More College Financial Aid."
That would be up from a current rate of 4.99%. The rate had been 3.73% for the 2021-22 academic year and had fallen as low as 2.75% for the 2020-21 year. We're moving farther away from those ultra-low rates during the pandemic.
The formula for undergraduate direct loans involves adding 2.05 percentage points to the 10-year Treasury rate.
Kantrowitz currently would expect new rates of 7.05% on Federal Direct Stafford Loans to graduate students and 8.05% on Parent PLUS and Grad PLUS loans. Again, roughly a half of a percentage point higher than last year.
When it comes to graduate federal student loans, the formula involves adding 3.6 percentage points to the 10-year Treasury rate. The rate for PLUS loans adds 4.6 percentage points.
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We won't know a solid estimate for federal student loans ahead until that May 10 auction. It's possible the Treasury benchmark could fall on expectations that the latest Fed rate hike could be the last and worries about a U.S. recession continue to build.
These federal student loans have a fixed interest rate for the life of the loan. If you got a bargain on super-low federal student loan rates a few years ago, you're able to hold onto that fixed rate.
All student loans aren't the same
May 1 was National College Decision Day when many high school seniors select where they'll head to college in the fall. As students plan for college, though, they're going to need to take a harder look at what kind of loans they want to take out — and where else they're going to find some cash.
Best bets: Keep searching for scholarships, work summer jobs for cash and keep a lid on spending.
Students should opt to take out federal student loans first. The maximum in federal direct loans allowed for dependent undergraduate students is $5,500 for freshmen — and no more than $3,500 of that amount can involve subsidized loans, according to the U.S. Department of Education.
"Federal student loans have much more attractive forbearance, deferment and forgiveness policies. Income-based repayment is another perk of federal student loans," said Ted Rossman, senior industry analyst for CreditCards.com and Bankrate.com.
Many times, parents will then tap into PLUS Loans, which carry higher rates but fill a gap. How much parents can borrow on a PLUS loan varies. The amount is based on the cost of attendance at a specific college minus any other financial assistance the student receives. The school determines the figure for the cost of attendance.
Students who take out private student loans need to realize that some of those loans are fixed but others have variable rates, which go up when the federal funds rate moves higher.
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"Anyone who took out a variable rate loan a few years ago has definitely suffered from the Fed’s recent wave of rate hikes," Rossman said.
"Conversely, it’s likely that rates will fall in the years to come, but there are no guarantees," he said.
Private student loan debt often comes with a higher price tag and interest rate, especially for those with low credit scores. And there is no possibility for loan forgiveness under federal relief programs.
To get the lowest rate on a private student loan, you'd need strong credit or a co-signer with a strong credit score. Private student loan rates can range currently from about 4.5% to 15%, depending on the program, the lender and your credit score, according to rates quoted on LendingTree in early May.
Most private student loans will require a creditworthy co-signer.
While getting a parent to co-sign for a private student loan might sound simple, parents can put themselves at risk if the student initially agrees to pay the bill but then later misses payments or cannot pay off the loan.
When will repayments on old student loans resume?
During the past year, much focus on student loans has centered on the well-publicized effort by President Joe Biden to forgive up to $10,000 in federal student loan debt or $20,000 for those who received a Pell grant.
Under the forgiveness plan, borrowers with an annual income during the pandemic of under $125,000 for individuals — or under $250,000 for married couples — would be eligible.
The broad-based forgiveness program is very much in flux, though, and remains in the hands of the U.S. Supreme Court after legal challenges to the program. Repayment could resume 60 days after the decision is announced.
Nearly 1.43 million borrowers in Michigan owe $51.7 billion in federal student loans, according to the U.S. Department of Education. The average debt is $36,177.
As part of pandemic-related relief, borrowers with federal student debt have gone a bit more than three years without having to make a federal student loan payment. Their debt wasn't forgiven then, but the payment pause had been extended repeatedly to offer budgets more breathing room.
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Many experts warn that repayments could start up again in September or October. Borrowers are expected to be notified by Aug. 31 of the payment resumption.
Interest — which had been put on pause for three years — would start being charged again.
Some borrowers might be under the impression that repayment would be paused again. Or that somehow the relief could be extended even further if the Supreme Court rules in favor of student loan forgiveness.
Kantrowitz cautioned: "Repayment will restart regardless of how the court rules. Even if the court rules in favor of the president's plan, two-thirds of the borrowers will still have some federal student loan debt after forgiveness."
College students must prepare to pay higher rates ahead; and college grads and others with federal student loan debt need to get ready to resume monthly payments.
Contact Susan Tompor: stompor@freepress.com. Follow her on Twitter @tompor. To subscribe, please go to freep.com/specialoffer.