Interest rates on federal student loans change annually on July 1 and are fixed for all new loans made through June 30 of the following year. The interest rates are constant and do not change over the life of the loan.
New interest rates are set based on a formula that uses the high yield of the last 10-year Treasury Note auction in May, plus a margin. Congress enacted an interest rate formula as part of the Higher Education Act of 1965. The current formula has been in effect since 2013.
Here’s an example of how the formula works.
The Treasury Note’s high yield on the May 11, 2022, auction was 2.94%. A 2.05% margin was added to this for a 4.99% interest rate on undergraduate Federal Direct Stafford Loans.
The margin is 3.6% for graduate Federal Direct Stafford Loans creating a 6.54% rate, and 4.6% margin for Federal Direct Grad PLUS and Parent PLUS loans, making a 7.54% rate.
Rates for student loans for 2023-2024 will be set the same way in May 2023.
Why Student Loan Rates are Rising
Rates are rising for student loans. Here’s what is driving those increases.
Source: Bankrate.com
The Federal Reserve has increased rates several times in recent months to drive down inflation. When that happens, the cost of borrowing money rises in all areas from mortgages and car loans to credit card rates and student loans.
While the Fed doesn’t directly set Treasury yields, yields typically rise when the Fed rate increases. With the size and amount of times the Fed’s rate has risen, student loan borrowers could be in for a shock when applying for loans in 2023-2024.
What You Should Do Based on Current Conditions
Although it’s widely accepted that a considerable rate increase is coming, federal student loans are often the best choice for college students. The rates set for the school year apply to all borrowers, regardless of credit score, and borrowers generally do not need a co-signer to secure student loan debt.
Private student loans may advertise slightly lower rates, but most borrowers will not qualify for those rates. Private student loan rates will also increase; for borrowers who take out variable APR loans, hefty increases may also occur throughout the year.
While you can’t control the interest rates on federal student loans, other benefits make them more attractive than their counterparts. For example, federal student loans offer loan forbearance, deferment, income-driven repayment plans, and customizable repayment options.
However, private loans can be a good option for student borrowers in some cases. They may make sense if you’ve already borrowed the maximum in subsidized and unsubsidized federal student loans. If you have good credit of 690 or above or have a co-signer who does, your level of eligibility may put you in line for the most favorable interest rates from loan servicers that are competitively positioned vs. federal student loans.
Your best move is to apply for federal student aid through FAFSA. If you’re approved for a federal loan, you have the option of declining to accept any federal student loans at the new interest rates. You’ll have a baseline that you can use to compare and shop for the best loans based on your needs.
To keep your loan costs at a minimum, only borrow what you need and resist the temptation to take on unnecessary added loan amounts. The more you borrow, the higher the interest rate will add to your total cost of borrowing.
Another long-term strategy is to refinance your federal student loans later if interest rates drop and move favorably. Be aware that if you refinance a federal loan and switch to a private lender, you’ll lose the benefits mentioned above. Some borrowers also refinance if they have multiple loans with different interest rates to save money and simplify their tracking and monthly payments.
If you’re considering a private student loan, compare offers from multiple lenders such as banks, credit unions, online companies, and state-based lenders to find the best rates. Consider both fixed and variable-rate loans to get the best student loan for your situation, knowing that variable loans usually start lower than a fixed rate but could increase or decrease over time depending on economic conditions.
Each lender will have its requirements for taking out a loan, but most focus on credit scores and income. You’ll also need to provide documents that prove citizenship, identity, income, school attendance, cost information, or a financial aid award letter from your college as part of the credit check and financial need process.
Because students generally have limited income, co-signers are often used for private loans. Some lenders have loans for borrowers without a co-signer and instead will consider future career and income potential.
If you have poor credit and can’t find a co-signer, you will probably have more luck with a federate student loan because they don’t require borrowers to demonstrate creditworthiness.