Student loan interest rates are set to rise in the coming months. Here’s what it means for millions of borrowers.
Interest Rates On New Federal Student Loans Set To Increase
Interest rates for new federal student loans are set by Congress. Current federal law ties the interest rates to the 10-year Treasury yield plus a premium, and fixes the rates based on the year of disbursement. Interest rates on new federal student loans will increase this summer for all newly disbursed federal student loans:
- Undergraduate federal Stafford loan interest rates are set to increase from 3.73% to 4.99%.
- Graduate federal Stafford loan interest rates are set to increase from 5.28% to 6.54%.
- Federal PLUS loan interest rates are set to increase from 6.28% to 7.54%.
Seemingly small interest rate changes to student loans can make a signifiant difference to the cost of repayment. For a $20,000 federal student loan balance, the interest rate change would result in an additional $252 in interest accruing annually. On a 10-year Standard repayment term, an undergraduate student loan borrower with an original balance of $20,000 would pay over $1,400 in additional interest at the higher rate.
The interest hike is scheduled to take effect on July 1, 2022.
Interest Rates On Most Existing Federal Student Loans Are Still Set to Zero — But That Is Set to Expire
Importantly, the interest rate hikes only apply to new federal student loans disbursed on or after July 1, 2022. Older federal student loan interest rates disbursed by the U.S. Department of Education are fixed based on the interest rates set at the time of their disbursement (which, depending on the year and the associated rate, could be good or bad for the borrower).
However, interest rates on all government-held federal student loans have been temporarily set at zero for over two years through the CARES Act, which also paused all student loan payments. That payment pause and interest freeze was recently extended by President Biden to August 31, 2022. Unless Biden extends the relief further, interest rates on all government-held federal student loans will ultimately revert back to their original fixed rates in September.
Biden Administration Considering Some Changes to Student Loan Interest
Student loan interest can be debilitating for borrowers. During most periods of nonpayment (including some deferment periods, as well as forbearance and most grace periods), interest typically accrues. This leads many borrowers to wind up owing much more than what they originally borrowed by the time they begin repayment.
For student loan borrowers on an income-driven repayment plan, which allows them to repay their loans using a formula tied to their income, their normal monthly payment may not even be high enough to cover all of the accruing interest each month, resulting in ongoing balance growth.
To make matters worse, that accruing interest can be periodically capitalized, or added back on to the principal balance. This can have a compounding effect over time, resulting in substantial balance increases for some borrowers. Accrued interest can capitalize for a number of reasons such as entering repayment, changing repayment plans, failing to re-certify income under an income-driven plan, or ending a forbearance.
The Biden administration is finalizing regulatory changes that would eliminate a number of interest capitalization events. “When capitalization occurs, borrowers see balances rise faster as interest accrues on interest,” said the Department of Education in a statement last year. “Interest capitalization is not a common practice across other consumer financial products.” The administration is moving forward with a plan to eliminate interest capitalization for entering repayment, leaving a forbearance, changing certain income-driven repayment plans, and entering default.