When I finished my graduate program at Syracuse University, the interest rate for federal Stafford Loans (now called Direct Loans) was 2.77%. I consolidated the loans and locked in a low interest rate — one that decreased when I agreed to automatic withdrawal.
On top of that, after I made 36 on-time payments, I received another drop to my interest rate. It’s why I now pay 1.9% APR on my student loans and have no intention of paying them off early.
But why do I have such a low interest rate on my student loans while my ex, who consolidated his federal loans eight years after I did, pays an interest rate of about 5%?
The answer lies in the way student loan rates are set, and the changes to the way they have been set over time.
Factors that affect interest rates for federal loans
Federal student loan interest rates are set by Congress. In the past, rates were set somewhat sporadically.
Today, thanks to the Bipartisan Student Loan Certainty Act of 2013, Congress is required to set new loan rates for the following school year every spring. The rates are good for the life of the loan, and the award year runs from July 1 to June 30.
Congress sets rates depending on the type of loan, taking into consideration whether the loan is for graduate or undergraduate students and whether the loan is subsidized or not.
Direct PLUS Loan rates are also set at this time. Federal Perkins Loans were set to 5% all the time, but the program expired on Sept. 30.
When Congress decides what rate to set, it looks at the financial markets — particularly the rate of 10-year Treasury notes — and adds a premium. The 2013 law requires student loan interest rates to follow market trends.
This explains why rates for the 2016-2017 school year are relatively low at 3.76% for undergraduate loans and 5.31% for graduate loans. With rates low and the financial markets still in recovery mode, student loans follow suit.
However, it’s worth noting that, as the economy improves and markets become more confident, student loan interest rates are likely to rise. In light of this, it’s probably a good thing the 2013 law also put caps on how high the rates can go:
- 8.25% for undergraduates
- 9.5% for graduates
- 10.5% for PLUS loans
Consolidating your federal student loans
When you consolidate your loans, the process is a little different than it used to be. I was able to lock in a low interest rate with a private loan servicer when I finished in 2005. Things were different by the time 2013 rolled around and my ex consolidated his loans.
Now, you consolidate your federal student loans through the direct program. When you consolidate this way, your new interest rate is an average of the rates on your original loans.
Each year you were in school, you got new loans at new rates. Because my ex’s student loans ranged from 3.76% to 6.80%, he ended up with a rate in the 5% range for his consolidation.
Federal student loans don’t come with a refinancing program; you can only consolidate. However, there are additional protections with federal loans, including income-based repayment.
Factors that influence interest rates for private loans
The story is a little different when you look at private loans.
Federal student loan servicers have to follow the guidance from Congress. However, private lenders have no such requirements. This is why, when I had a private student loan, I paid 6.8% APR (and why I decided that one was worth paying off quickly).
Private lenders often set their rates based on either the Prime Rate set by the Federal Reserve, or the London Interbank Offered Rate (LIBOR). A premium is, once again, added to the base rates offered by private lenders.
The Prime Rate and the LIBOR are set based on financial markets, economic conditions, and the ways the setting authority wants to pursue monetary policy.
However, there are other factors that affect interest rates on private loans, including whether you choose a fixed or variable rate and your credit history. Because private lenders are very interested in getting their money back, your credit history is going to be the most important of the factors that affect interest rates.
While it’s possible to get low rates with a private lender — perhaps better rates than what you would get with federal loans — it’s important to realize that the low advertised rate isn’t guaranteed.
There aren’t credit requirements to federal student loans. When you apply for a federal loan, you automatically get the rate set by Congress.
With private student loans, though, your credit matters a great deal. If you want to get a good rate on a private student loan or refinance, you need to build your credit.
Your best bet is to compare interest rates and shop around when you decide to apply for a private student loan, whether you are getting a new student loan or refinancing existing loans.
Student loan interest rates are always changing. It’s important to pay attention to the rates when you get your student loans, and also know what influences interest rates. You’ll have a better idea of what to expect as you plan your education.
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