Federal interest rates on student loans are considerably lower than they used to be. In fact, borrowers paid 6.80% on direct unsubsidized loans for the 2012-13 school year, which seems unfathomable at the moment given our low interest rate environment.
For direct subsidized loans and direct unsubsidized loans for undergraduate students disbursed on or after July 1, 2020 and before July 1, 2021, the current rates are set at 2.75%. Meanwhile, graduate and professional students with direct unsubsidized loans pay 4.30%, and parents and graduate or professional students with Direct PLUS loans pay 5.30%.
Each year the month of May brings another change to federal student loan rates from July to June of the following year. Rates are announced in June based on the May Treasury auctions, so we can know right now what the rates will be.
The new rates for Direct Subsidized Loans, Direct Unsubsidized Loans and Direct PLUS Loans first disbursed from July 1, 2021 and before June 30, 2022 will be as follows:
- Directly Subsidized or Unsubsidized Undergraduate Loans: 3.734%
- Direct loans to unsubsidized graduates: 5.284%
- Direct PLUS Loans: 6.284%
What do these new rates mean to you as a borrower? Maybe nothing, but it depends on the type of loan you have and other details of your situation.
What do rate increases mean for borrowers?
If you already have Federal Student Loans, this year’s new rates will not affect your student loan interest rate or monthly payment. That’s because federal student loans all come with a fixed interest rate, which means your interest rate and monthly payment never changes.
You might feel like you’re being punished if you consolidate your federal student loans with a direct consolidation loan, but that won’t give you a new interest rate, either. Why? Direct consolidation loans use the weighted average of your existing interest rates to set your new rate, so they won’t penalize you in interest if federal student loan rates go up for new borrowers.
Borrowers who have federal student loans should also be quiet for now, or at least not take drastic action. This is because the special forbearance period is in place for federal student loans due to COVID-19 and no payment is due until at least September 30, 2021. Interest is also set at 0 % for federal student loans, so you can skip payments without any accrued interest.
What about borrowers with private student loans?
If you have private student loans, changes to federal student loan rates will not affect your monthly payment or your loan repayment process. This is because private student loan rates are set separately from federal student loan rates, most of which are indexed to the one- or three-month LIBOR index, or the London interbank rate. Some private student loan rates are also prime rate based.
That being said, borrowers with private variable rate student loans can absolutely benefit when interest rates drop globally. When interest rates fall, the monthly payments on variable rates decrease with them. Of course, the reverse is also true, and higher interest rates lead to higher monthly payments on the same loan amount.
What is the impact of interest rate changes
If you are planning to take out federal student loans this year, you can expect to pay a little more due to the higher federal student loan rates. Since federal student loans all have fixed interest rates, you set a rate for the life of your loan. Even though they are slightly higher, they are still very low.
And don’t fall for the myth that higher rates mean your loan service company is making more money on interest. Federal loan managers are paid per loan, not based on the interest rate charged on the loan.
Federal student loans also come with an array of important protections for consumers, including the ability to stay or forbear, as well as the ability to pay off your loans with an income-based repayment plan.
That being said, there are situations where it might make sense to refinance federal student loans with a private lender – at least after September 30, 2021, when payments resume and interest begins to accrue.
For example, it may be a good idea to refinance federal student loans from a private lender if you have excellent credit and qualify for a much lower interest rate. This is especially true as lenders like College Ave offer refinance loans with fixed interest rates as low as 3.34% and variable rates as low as 3.24%. Just remember that refinancing federal loans with a private lender means forgoing options like income-driven repayment plans or Public Service Loan Forgiveness (PSLF).
If you already have private student loans and interest rates are dropping lower than what you are paying, then it makes perfect sense to look into refinancing. After all, private student loans do not have prepayment penalties, just like federal loans. This means that you can refinance your private student loan into a new loan at a lower rate without paying a penalty for it. Just be sure to be careful and avoid the hidden student loan fees that some lenders charge, like origination fees.
The bottom line
Federal interest rates on student loans have the potential to change each year, so this year’s move is no surprise. In addition, changes in federal interest rates on student loans do not affect existing borrowers. If you already have federal student loans, your rate is currently fixed and will never change unless you take steps to refinance your loans.
Also be aware that there are options that allow you to keep the federal student loan you have while enjoying a lower monthly payment. For example, you can switch from a standard 10-year repayment plan for your loans to a phased repayment plan or an extended repayment plan. You can also select an income based plan like Pay As You Earn (PAYE), Revised Pay as You Earn (REPAYE), Income Based Rembayment (IBR) or Income Contingent Rembayment (ICR). These plans allow you to pay a percentage of your discretionary income for 20 to 25 years before forgiving any remaining loan balances. If your income is low enough, the monthly payment for an income-based repayment plan could be as low as $ 0.
By the way, it always makes sense to pay attention to interest rates on private student loans, including how they change over time. If the rates are low enough, or if you have federal loans with above-average rates (like Direct PLUS loans), refinancing federal loans with a private lender could lead to thousands of dollars in savings.