How Are My Student Loan Interest Rates Determined?

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Anyone who borrows money to pay for college will have to pay interest on their debt. For recent graduates breaking into the job market, these rates can be painful. But while you may know how student loan interest rates work in general, you might be wondering how your lender or servicer sets them.

While the government sets federal loan rates, private loan rates are based on your — or your cosigner’s — financial history. Here’s how lenders determine student loan rates, and how today’s rates compare to previous years’. Specifically, let’s look at…

How are student loan interest rates set?

Federal student loan interest rates are adjusted by federal law each school year. These rates apply to all students regardless of their credit history.

Private lenders, on the other hand, set rates based on the creditworthiness of each individual applicant. They consider factors such as credit score, job history and income.

Although trends in the stock market and economy also affect both private and federal student loan rates, they do so in different ways. We’ll explore more about these differences below.

Who sets the formulas for federal student loan rates?

All federal student loan rates are set by Congress, according to the Federal Student Aid Office.

Congress passes the interest rates set by the Department of Education into law each year. The rates are based on 10-year Treasury notes, plus a fixed increase.

Student loan rates are set in the spring for each new school year. They are effective from July 1 to June 30 of the following year. To ensure interest rates don’t rise too high, Congress also includes rate caps for each type of student loan.

Here’s the formula used for different types of loans, from the Congressional Budget Office (CBO):

  • Direct unsubsidized loans for undergraduates: 10-year Treasury + 2.05%, capped at 8.25%
  • Direct unsubsidized loans for graduates: 10-year Treasury + 3.60%, capped at 9.50%
  • Direct PLUS loans: 10-year Treasury + 4.60%, capped at 10.50%

Based on the above formula, undergraduate students pay the least to borrow for college. Parents and graduate students will usually pay more to finance educational costs.

The Department of Education approves borrowers for federal student loans based on need. To qualify, apply using the Free Application for Federal Student Aid, known as the FAFSA. Factors such as a student’s or family’s income will affect how much aid they receive. But these factors have no effect on the federal student loan rates each borrower pays.

How do lenders set private student loan rates?

To get a private student loan, you will apply directly to the lender. Each private lender has its own underwriting process and standards for student loan applicants; these eligibility requirements help lenders decide whether to give an applicant a loan, and at what interest rate.

To qualify for a private student loan, you must meet the lender’s underwriting standards — or apply with a cosigner who does. Common eligibility requirements for approval include your credit score, credit history — such as whether you’ve paid bills on time — and income. The lender might also consider factors such as what degree you are working toward and your career history or field of study.

Unlike federal student loans that offer universal rates, private lenders use their own lending models to set and offer individualized rates for each borrower. Here are the three main factors that affect the rates lenders offer on private student loans.

1. Your credit score

Lenders use your credit score and history to set private student loan interest rates. Typically, the better your credit, the more likely a lender is willing to finance a loan at a lower rate. That’s because you’ve shown you’re capable of repaying your debts and pose a lower risk of default.

To get the most favorable rates and terms on a private student loan, lenders generally require a credit score in the good-to-excellent range, which means a score of at least 670 — but the higher, the better.

To maintain a good credit score:

  • Stay current on your debt payments: Make full and timely payments each month. Payment history is the single biggest factor in determining your credit.
  • Keep revolving debt low: Use as little of your available credit as possible, particularly on credit cards, to maintain a low credit utilization ratio. Experts recommend keeping it under 30% at all times.
  • Maintain older accounts: Lenders like to see long credit histories, which show that you can responsibly use credit over time.

2. Your student loan terms

The terms you choose on your private student loans will also influence the interest rates you’re offered.

For instance, lenders commonly offer variable interest rates on student loans. Choosing one will often get you a lower introductory rate than a fixed-rate loan, but the variable rate could increase in the future. You will also typically get a lower student loan interest rate if you choose a shorter repayment period.

3. Market trends

Private student loan interest rates are also typically based on a more general benchmark interest rate — similar to how federal student loan rates are tied to 10-year Treasury bond rates.

Student lenders most commonly set rates according to the LIBOR (London Interbank Offered Rate) or the prime rate. These reflect larger economic forces and market prices.

What are current student loan rates?

Federal student loan rates are still fairly low for the 2019-20 school year, historically speaking. In fact, 2019-20 rates are approximately half a percentage point lower than 2018-19 rates.

  • 2019-20 Direct subsidized loans for undergraduates: 4.53%
  • 2019-20 Direct unsubsidized loans for graduates: 6.08%
  • 2019-20 Direct PLUS loans: 7.08%

Current student loan rates from private lenders are also fairly low. The best private student loan providers offer rates starting as low as around 4%. That’s a little bit lower than undergraduate rates on federal student loans. But that only reflects the lowest rates these lenders offer. Many borrowers won’t qualify for rates in this range. Private student loan rates can reach as high as 15% or more.

Comparing historical and current student loan rates

Current student loan rates are nearly four percentage points lower than the rate caps that mark the highest possible student loan rates. The current formulas and caps on federal student loan rates are fairly new: They were instituted in 2013 with the passage of the Bipartisan Student Loan Certainty Act.

Where are student loan interest rates headed?

In January 2017, the CBO predicted that federal loan interest rates would increase by about 0.25% to 0.4% each year for the next four years, before leveling out at 5.5% to 5.65%. Two years later, interest rates are below the predicted level.

Looking to the future, in June 2019, the Federal Reserve said additional interest rate cuts for the year were unlikely, but that a rate cut was possible in 2020.

Overall, today’s student loan rates are low by historical standards. To take advantage of today’s rates, consider taking these steps:

  • Research student loan refinancing to see if you could get a lower interest rate compared to what you’re already paying.
  • Look into private student loans alongside federal student loan offers, especially if you’re a parent or graduate student facing higher interest rates. Today’s private student loan rates often beat those offered on PLUS loans.
  • Work on improving your credit so you can qualify for the best student loan rates.

Borrowers should carefully consider student loan offers. By knowing how student loan rates are determined, you’re better equipped to compare options and make the best choice for your situation.

Peter Fleming contributed to this report.