If you have a student loan, here’s what happens when the Fed lowers rates


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If you borrowed money to attend college, you most likely won’t feel any impact when the Federal Reserve cuts interest rates. That’s because most of the 45 million Americans with student loan debt have fixed interest rates, which means that payments don’t change for the life of their loan. Even then, the majority of borrowers have federal student loans, and Congress determines those interest rates, not the U.S. central bank.

But not all borrowers have fixed-interest student loans. Those with variable interest rates are the most affected when the Fed makes cuts. If you have private student loans with variable interest rates, here’s how the Fed rate cuts impact you.

How interest is calculated on a student loan

Almost all loans have added interest, whether you have federal or private student loans. But how that interest is calculated depends on the type of loan you borrowed, who your lender is and the type of rate you have. Most recent federal loans have fixed interest rates, or rates that don’t change for the life of the loan. If you have private student loans, you could have fixed or variable interest rates, or rates that fluctuate based on the Fed rate.

Federal student loans

Congress determines interest rates on federal student loans, and those rates change every year. The type of loan you have and when you borrow will determine your interest rate, but the interest rate for each type of loan is the same for all borrowers, regardless of credit score or financial profile.

For undergraduate borrowers who take out a Direct Subsidized or Unsubsidized Loan starting July 1, 2020, interest rates will be 2.75 percent. Graduate and professional borrowers will pay 4.3 percent on Direct Subsidized Loans, while Direct PLUS Loan borrowers will pay 5.3 percent.

Private student loans

Interest rates for private student loans are determined by your creditworthiness. If you have a strong credit history, you could get the lowest interest rates offered. This goes for both fixed- and variable-interest-rate loans.

Variable interest rates mean that your interest rate — and in turn, your monthly payment — change depending on the Fed rate. The Fed rate is the result of what banks charge each other to borrow and lend money when they make transactions overnight.

Private student loan lenders use the London Interbank Offered Rate (Libor) on top of an average market rate. Variable interest rates tend to start out lower than fixed interest rates but could be more if the Fed rate goes up.

How Fed rates impact student loan interest

Not all student loans are affected by the Fed rate. It comes down to the type of loan you have and the type of interest rate on that loan.

If you have a federal student loan

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 on loans, such as credit cards and auto loans. Essentially, if the Fed hikes or cuts the fed funds rate, interest rates on those loans respond in kind.

That’s not the case for federal student loans. Lawmakers meet annually to determine interest rates for loans taken out during each subsequent school year. For instance, policymakers met last spring to determine how much it’ll cost to take out a student loan between July 1, 2020, and June 30, 2021.

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.

The bottom line: Federal student loans you’ve already taken out won’t see any impact. However, students borrowing money for the 2020-21 school year can benefit from some of the lowest rates in over a decade.

If you have a variable-rate student loan

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.

Most student loans with variable rates come from private, nonfederal sources. This means that the lender that offered the loan determines the interest rate. That rate is pegged to the federal funds rate, so it typically responds to any Fed adjustments. Some loans could be tied to the prime rate, which is also tied to the federal funds rate.

The bottom line: Variable interest rates are tied to the Fed rate. When the Fed rate goes up, your interest rate goes up and you’ll face a higher monthly payment. When it goes down, you could be paying less per month.

What you should do if your student loan rate is variable

If you have a student loan with a variable interest rate, the Fed lowering interest rates may act in your favor, since lenders will be all but forced to lower interest rates. But sometimes it’s not wise to take on the extra risk by taking out a variable student loan.

Remember that your interest rate might start out lower than fixed rates, but it has the potential to climb higher.

It’s important to read the fine print on the terms of your loan, especially if you have a variable rate. That includes seeing if your lender has a cap on how high or low the interest rates can go.

With rates falling, you might want to refinance your student loans. If you shop around for the best rate, you could be saving money by shaving off a percentage point or two from your interest payment. You could save hundreds or even thousands of dollars over the life of your loan.

When to refinance

Regardless of if you have federal or private student loans, you have the option to refinance your student loans. This is when you take out a new loan with a new interest rate and repayment terms, pay off your old loans and then make 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. With private student loans, you have only what the lender offers, and not all of them have similar benefits to federal student loans.
  • 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 to that. 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.

Next steps

If you have federal student loans or fixed-rate private student loans, you won’t feel much of an impact from the Fed rate changes. But if you have variable-interest-rate loans, these changes make a difference, and sometimes those differences can occur from one month to the next. When the Fed rate drops, you could face a lower interest rate. When it goes up, you could end up paying more.

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