If you’ve watched the news or scrolled past financial headlines lately, you’ve probably noticed a lot of commotion about when the “Fed” will hike up the interest rate next. According to several news outlets, the next rate increase is expected to be announced this week – and the change will affect many facets of our economy, like mortgages, credit card rates, and some student loans.
The fact is, however, that a lot of us who aren’t completely sure what a Fed interest rate hike means for our everyday lives. And with so many people working toward paying off student loan debt, how will the Fed’s decision impact our interest rates?
Before we get into the impending rate hike, let’s run through the basics of the Fed and what it does.
Why Does the Fed Periodically Increase the National Interest Rate?
The Federal Reserve – almost always referred to as simply “The Fed” – is the central bank of the United States. Even though Congress created the Fed and continues to exercise oversight over the organization, it’s an independent entity. The Fed’s main job is to help the country maintain low unemployment and stable prices for American consumers.
One of the Fed’s most-used tools that it relies on to influence the economy is the federal funds rate – also known as the benchmark interest rate. This particular interest rate represents the rate at which depository institutions, like typical banks, lend funds to other depository institutions overnight. It serves as a benchmark, or point of reference, for interest rates that regular people like you and me end up with when we borrow money.
When the economy isn’t doing well, the Fed increases the benchmark interest rate in order to rejuvenate the sluggish market. That way, people can borrow money at a lower cost during times of economic slowdown – and consumers can get out of debt and start participating in the economy sooner. Lowering the benchmark interest rate also sparks more hiring.
When the economy is doing well, the Fed increases the benchmark interest rate by small increments (0.25%, for example) in order to keep up with inflation and prevent hyperinflation. When the market is doing better, consumers are ready to borrow more, and the Fed increases the interest rate to “catch up” with the improving economic climate.
The organization’s Federal Open Market Committee (FOMC) gets together eight times a year to discuss whether or not to increase interest rates. After the financial crisis of 2008, the Fed cut the interest rate to between 0% and 0.25% - where it stayed until December 2015.
By then, the economy had recovered enough to handle a hike to the new range of 0.25% to 0.50%.
Since that historic 2015 increase, the Fed has ticked up the interest rate three times:
- December 14, 2016: from 0.25% to 0.50% to 0.50% to 0.75%
- March 15, 2017: from 0.50% to 0.75% to 0.75% to 1.00%
- June 14, 2017: from 0.75% to 1.00% to 1.00% to 1.25%
Economic experts have come to the consensus that the interest rate will be notched up to 1.5% by the end of 2017. The next FOMC meeting will be held on December 13, 2017 – the last meeting of the year.
After that, experts are forecasting the federal funds rate will reach 2.0% in 2018, and then 3.0% in 2019.
But How Will These Changes Impact Student Loan Borrowers?
The increasing fed funds rate directly influences short-term interest rates, like for credit cards, Treasury notes, mortgages and corporate bonds. As for the interest rates on your student loans, the fed hike can affect you too – depending on which type of student loan you have.
If you took out a federal student loan:
The bright side is that if you signed up for a fixed interest rate, then your rate will remain unchanged.
If you signed up for a variable interest rate, like the majority of federal student loans approved before July 1, 2006, then you’re probably going to see your interest rate inch upward after some time. It will probably be an addition of just 0.25% or 0.5%, but that can make a difference to a lot of households as the months build up.
As for taking out new federal student loans, in June it was announced that the federal loan interest rates for this year’s application season would be boosted to 4.45% - up from last year’s 3.76%. College tuition rates are growing, as is the cost of borrowing to foot the bill.
If you took out a private student loan:
These notoriously come with heftier interest rates already, but the same rule applies: the Fed’s rate hike might increase your rate if you signed up for a variable interest rate.
If you took out a private loan with a fixed interest rate, you have nothing to worry about.
Either way, the ripple effects of the Fed’s rate hike won’t happen overnight – and the effect it has on your student loan will most likely be equal to the percentage increase of the federal fund rate.
How Can You Prevent Your Private Student Loan Interest Rate from Rising?
On the bright side, there are several companies that you can use to refinance your federal or private student loans – at both fixed and variable rates.
If you apply online with one of these refinancing companies, and lock in a low, fixed rate now – your interest rate will be unaffected by any future rate boost by the Fed. Even some of the variable rates you get offered can be more affordable than what you’re paying now, and still be cheaper after a federal funds rate hike. Refinancing a federal or private student loan can be the most affordable option, but you’ll never know until you apply – and make sure you fully understand the terms and conditions of the loan you are considering.