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How the Fed impacts student loans

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If you borrowed money to attend college, you may never feel any impact if the Federal Reserve adjusts interest rates. That’s because most Americans with student loan debt have fixed interest rates, which means that monthly payments don’t change for the life of their loans.

But not all borrowers have student loans with a fixed rate, and those with variable interest rates will see changes any time the Fed raises or lowers rates. If you have student loans, here’s how the Fed decisions might impact you.

Key takeaways

  • Interest rates on federal student loans are always fixed. These rates are set on July 1 each year for loans disbursed from July 1 to June 30 of the following year.
  • Federal student loan interest rates are determined based on the high yield of the last 10-year Treasury note auction in May, plus a margin that varies based on the type of federal loan.
  • Borrowers with existing federal student loans will not see any changes when the Fed lowers interest rates.
  • Borrowers with variable-rate student loans from private lenders may see their interest rate change when the federal funds rate changes.

How student loan interest is calculated

All student loans, both federal and private, accumulate interest at one point or another. Even so, the way the interest is calculated depends on the type of loan you utilize, who your lender is and the type of rate you have.

With federal student loans, Congress determines fixed interest rates each school year. Last spring, policymakers met to determine how much it costs to take out a student loan between July 1, 2021, to June 30, 2022, and they’ll meet again this spring for the 2022-23 school year. The type of loan you have and when you borrow determines your interest rate, but the interest rate is the same for all borrowers regardless of credit score or financial profile.

Private student loan lenders use the London Interbank Offered Rate (Libor) on top of an average market rate. Your exact interest is also determined by your credit score and whether you choose a fixed or variable rate.

How does the Federal Reserve affect student loan interest?

While the federal funds rate isn’t the exact interest rate you’re charged for taking out credit, it serves as a benchmark for the rates you have to pay for things like auto loans or personal loans. Essentially, if the Federal Reserve hikes or cuts the fed funds rate, interest rates on those loans respond in kind.

Even though the Fed doesn’t have direct control over student loan interest rates, you might start to see them react the same way. That’s because Congress ties interest rates to external market forces, mainly to the 10-year U.S. Treasury yield. The same factors influencing those returns are also dictating Fed officials’ decision-making.

If you already have a fixed-rate student loan, decisions made by the Federal Reserve won’t affect you at all. However, if you’re taking out a new loan, your rate will be reflect current trends. If your student loan has a variable interest rate, you’ll feel the Fed rate changes the most; when the Fed raises or lowers borrowing costs, your interest rates will likely respond. This could mean that you pay more or less in interest over time, depending on how the Fed rate changes.

With the Fed expected to raise rates in 2022, borrowers with variable student loans can expect to see a slight bump to their interest rate. Federal student loan interest rates for the 2022-23 school year may also be higher than in recent years.

How to respond to Fed rate changes

In an environment with fluctuating interest rates, your next best steps can vary from doing nothing at all to refinancing your loans. Here are some tips that can guide you based on the type of student loans you have:

  • If you have a federal student loan: If you have federal student loans, rising interest rates won’t impact your loan payment or the interest you pay. It’s best to stick with your current loans.
  • If you have a fixed-rate private student loan: If you have private student loans with a fixed interest rate, Fed changes won’t affect you, since a fixed interest rate is locked in for the duration of your repayment period. With that being said, you can always check with lenders to see whether you could refinance into a new loan with a lower fixed rate.
  • If you have a variable-rate private student loan: If you have a private student loan with a variable interest rate, you can see your monthly payment and monthly interest charges change based on market conditions. If the rate change raises your monthly payment, shop around to make sure that you’re getting the best rate available based on your credit score and other factors. You may choose to refinance into a fixed-rate loan if rates are expected to rise further.

When to refinance

Regardless of whether you have federal or private student loans, you have the option to refinance your loans to get a better deal. Refinancing is the process of taking out a new loan with a new interest rate and repayment terms, paying off your old loans and then making one payment to your new loan.

You should refinance your student loans if:

  • You have a solid credit score. Since you’re taking out a loan with a private lender, your credit score and credit history will determine your new interest rate. If you don’t have an excellent or even good credit score, your interest rate will be higher than that of someone who has a better score.
  • You have private student loans. Federal student loans come with a number of protections, like deferment, forbearance and income-driven repayment plans. Those go away when you refinance. If you have private student loans already, you don’t stand to lose these benefits.
  • You’ll get a lower interest rate. If you have a high interest rate — whether it’s fixed or variable — a good chunk of your monthly payments might be going toward interest instead of your principal balance. If you can secure a lower interest rate, you’ll get a lower monthly payment. If you’re struggling to make payments now, this might be your biggest determination for refinancing.
  • You have variable-rate loans. Student loans could become more expensive over the next few years as the Fed starts to raise interest rates again. You may choose to refinance into a fixed-rate loan now in order to lock in a cheaper loan.

Next steps

The Fed’s decisions won’t necessarily impact your student loans. That said, if you have a variable student loan rate, or if you’re hoping to take out a new student loan, it’s worth keeping an eye on how the federal funds rate changes. Timing your student loan correctly could help you save money on interest over time.

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Written by
Sarah Foster
U.S. economy reporter
Sarah Foster covers the Federal Reserve, the U.S. economy and economic policy. She previously worked for Bloomberg News, the Chicago Tribune and the Chicago Daily Herald.
Edited by
Student loans editor