Last week, the Federal Reserve raised interest rates. How will the hike impact student loan borrowers?
On Wednesday, the Federal Reserve raised short-term interest rates by 25 basis points (or 0.25 percent) after months of a strong economy. This marks the Fed’s sixth consecutive hike and first increase under the newly appointed Chairman Jerome Powell.
When the Fed raises the federal fund rates, it makes it more expensive for banks to borrow money. This creates a ripple effect where banks often increase their rates for customers, which in turn affects consumer lending. Individuals are especially vulnerable if they have a variable interest rate.
The rate increase has left many borrowers wondering what this will mean for their student loan debt. For many of the borrowers who rely on federal loans, the rate hike won’t affect their payments. Federal loans issued after 2006 have fixed rates; borrowers who took out federal loans prior to 2006 should check to see if they have a variable-rate loan or a fixed-rate loan.
But over a million borrowers use private student loans, which often have variable interest rates. Variable interest rates are usually based on the London Interbank Offered Rate (LIBOR). But LIBOR and the Federal fund rates are closely related so when one increases, the other often increases as well. So as the Fed raises the rates, borrowers with private loans are likely to pay more in interest.
What can borrowers do if they have a private variable-rate student loan and their payments suddenly go up? In some cases, the best course of action might be to do nothing. Borrowers who are able to pay off their loans quickly will often save money by opting for a variable-rate loan. But it’s still a good idea to keep an eye on rates as they go up and be sure to calculate the changes to see if other options – like refinancing – make sense.
However, since the federal fund rate increases have been minor so far, borrowers with variable-rate loans will likely only see small increases in their monthly loan payments for now.
For borrowers who appreciate the consistency of a set monthly loan payment, they can consider refinancing their current loan into a fixed-rate loan. Many companies give borrowers the option to refinance at no extra cost.
However, borrowers who are considering refinancing their student loans should make sure they understand their options first. For instance, borrowers who refinance federal loans into private loans will lose access to income-based repayment plans and loan forgiveness.