How Fed Rate Changes Affect Your Student Loans
Understanding interest rates and monetary policy can be confusing. This article will help you understand what you need to know about the fed rate regarding your student loans.
The Federal Reserve is the Central Bank of the United States. This central bank sets national monetary policy. And one of the most important things that it does set is the Federal Funds Rate.
Also known as the "Fed rate," this is the rate that banks charge when they lend money out overnight to other lending institutions.
No private borrower ever pays the Fed rate -- but when the Fed sets interest rates, it has an indirect impact on most types of debts that borrowers take on. This includes some student loans.
So if you're wondering, why did my student loan interest rate go up, it's worth looking at whether a change to the federal funds rate could be part of the reason.
Will the federal fund rate affect federal student loans?
The Fed fund rate doesn't have much, if any, impact on federal student loan rates.
If you have existing federal student loans
If you have existing federal student loans, a change to the federal funds rate won't impact you at all.
That's because all federal loans have fixed rates and the rate will never change over time. It doesn't matter how much interest rates set by the Fed go up or down -- your rate will remain what it was at the time you first took out the loans.
If you are taking out new federal student loans
If you are taking out new federal student loans, federal law dictates how rates are set. A specific formula is used, which is based on 10-year Treasury yield rates. Specifically the interest rates for:
- Direct Unsubsidized Loans for undergrad students equal the 10-year Treasury yield + 2.05%. There's a maximum cap of 8.25%.
- Direct Unsubsidized Loans for graduate students equal the 10-year Treasury yield + 3.60%. There's a maximum cap of 9.50%.
- Direct PLUS Loans for parents or grad students equal the 10-Year Treasury yield + 4.06%. There's a maximum cap of 4.60%.
It is the Treasury Yield that dictates the rate that current and future borrowers will pay for federal student aid.
While 10-year treasury notes and the Fed's interest rates often move in tandem, they aren't the same. The federal funds rate can impact treasury-yields, but ultimately supply and demand in investor auctions is the biggest driver of them.
Will the federal fund rate affect private student loans?
If you have private student loans, a change to the federal fund rate could have more of an impact. It depends whether you have fixed or variable rate private loans as well as what your lender's process is for setting rates.
Will your fixed-rate private loans be affected by a change in the federal funds rate?
A change in the federal funds rate is less likely to impact borrowers with fixed rate loans compared with variable rate loans. Here's how it can affect borrowing costs.
If you have already taken out a private student loan
If you have already taken out a private student loan with a fixed interest rate, then a change in the Federal funds rate will not have an impact on your interest costs.
That's because, like fixed rate federal loans, fixed rate private loans also promise to keep the rate the same for the life of the loan. It doesn't matter if the Fed makes a change, because your rate is locked in.
If you are taking out new private student loans
If you are taking out private fixed-rate loans for the first time, your rate will be determined by your lender's benchmark interest rate. In most cases, lenders don't use the Fed funds rate as their benchmark rate. Instead, they use LIBOR (London Interbank Offered Rate) or the prime rate in most cases.
While LIBOR and the prime rate also often move in tandem with short-term interest rates set by the federal reserve, they are their own independent financial indexes that are also affected by other factors besides the Federal Reserve's decisions on short-term rates.
Will your variable-rate private loans be affected by a change in the federal funds rate?
If you have variable-rate private loans, you could see your student loan interest rate increase if there's a Fed rate change. Again, though, this is only because other benchmark indexes tend to follow a similar pattern to the Federal Reserve's rate.
If you have existing variable rate loans
By definition, variable rate loans are variable -- they can adjust over time.
Most lenders tie their variable rate loans to LIBOR or the prime rate. So, if these benchmarks show rising interest rates, your loan rate -- and monthly payments -- will go up.
You should plan accordingly, so you aren't left asking, why did my student loan interest rate go up and struggling to come up with the money to pay your loans.
If you are taking out new variable rate loans
If you are taking out new variable rate loans, your starting rate will also be determined by current market rate conditions, as well as your individual financial credentials. Again, most lenders don't tie their rates to the Fed rate, but it can impact it because it reflects trends in borrowing costs.
What should you do if you're facing a student loan rate increase?
If you are concerned about the possibility of a student loan rate increase, it's a good idea to look into
refinancing your private student loans -- especially if you have a variable rate loan currently.
Refinancing to a fixed rate loan could help you to lock in today's historically low rates. This can give you the confidence of knowing that your rate and payment can't change as you work to pay back your student debt.
Juno can help you to find a student loan refinance loan at the most affordable rate given your situation. We get groups of buyers together and negotiate on behalf of group members to get them the best possible rates given their circumstances.
Christy Rakoczy Bieber
Christy Rakoczy Bieber is a full-time personal finance and legal writer. She is a graduate of UCLA School of Law and the University of Rochester. Christy was previously a college teacher with experience writing textbooks and serving as a subject matter expert.