Federal student loan interest rates for new borrowers are set to drop to their lowest in history, according to market levels May 12, possibly creating millions in savings for current and future students and their parents.
The new rates — which will apply to loans disbursed between July 1, 2020 and June 30, 2021 — are by law based on the yield of benchmark Treasury bills.
The record-low rates for the coming year’s student loans mark major drops from the previous year, as the coronavirus pandemic impacts financial markets. Specifically:
- Federal direct loan rates for undergraduates fell to 2.75%, down from 4.53%
- Rates on direct loans for graduates moved to 4.30% from 6.08%
- Parent PLUS and grad PLUS rates dropped to 5.30%, down from 7.08% currently
- Overall, U.S. student borrowers could collectively save more than $79 million a month in interest payments on their 2020-21 loans (close to $9.5 billion over the life of the loans)
Among those who stand to benefit most: Students who defer in-school payments or request a postgraduate unemployment deferment or forbearance upon entering a coronavirus-affected job market.
The new rates, as compared to the previous year’s, are as follows:
For Direct subsidized student loans, the previous record low was 3.40%, offered between 2011 and 2013. Direct unsubsidized undergraduate loan rates, meanwhile, reached a low of 3.76% in the 2016-2017 academic year.
New borrowers to see significant savings
Previously borrowed federal student loans aren’t affected by Tuesday’s news, but those taking out loans for the coming year could see significant short- and long-term savings, especially if they elect to defer repayment.
For example, a freshman who defers in-school payments for four years would see their balance accrue and capitalize interest at much lower rates than previous classes of graduates.
Or consider the case of a senior who borrows one last time before entering a tough job market. Assume they take out $5,000 at 2.75% and, a year later, request an unemployment deferment, thanks to the coronavirus-affected economy. Their balance would increase by $412 during their three-year break from repayment, according to our deferment calculator. (At the previous rate of 4.53%, it would have grown by $679, or an additional $267.)
Borrowers active in repayment will also see lower monthly dues, thanks to these reduced rates. In some cases, the new record-low rates could result in several thousand dollars’ worth of savings over the life of their loan.
The combined impact on all borrowers is significant. Student Loan Hero/LendingTree analysts estimate that these new rates would save borrowers a combined $79.1 million a month ($949 million per year), for an ultimate grand total of $9.5 billion (assuming borrowers repay their debt on a 10-year standard repayment plan)..
In reality, however, about 70% of federal loan borrowers take longer than a decade to repay their government-owned education debt. That means the average borrower who enjoys these lower 2020-2021 rates will actually save even more money in interest not accrued — and that $9.5 billion number could creep above $10 billion.
Of course, these estimates could also be on the high side if colleges experience a significant dropoff in enrollment for the coming school year, as many prospective students consider taking a gap year amid the challenges brought on by the coronavirus pandemic.
How federal student loan interest rates are set
As noted above, federal student loan interest rates are based on Treasury yields, and Tuesday’s auction was the final precursor to formal Congressional approval.
The 10-year Treasury note’s closing yield was included in formulas to determine the final fixed interest rate for each federal loan type. These are:
- 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%)
