Interest Rates and How They Affect Your Student Loans

Interest Rates and How They Affect Your Student Loans

The Effect of Interest Rates is Far From Simple

If you have student loans, you may be wondering how interest rates affect your student loans. It’s a good question. The effect of interest rates is far from simple, because the interest rates themselves can vary depending upon the type of loan, when you received it and your own credit rating.

Interest Rates: General Facts

Let’s start with some straightforward facts about interest rates in general. Interest rates are charged on all loans, of any type. An interest rate is the cost of getting a loan; the lender is paid for providing the loans, in a sense, by charging a certain amount of interest. It is one of the ways lenders make income to stay in business.

If you or your parents have a mortgage, you will be charged interest. If you have a car loan, you will be charged interest. Student loans are no different.

The higher the interest rate, the most you will pay in interest on loans.

Interest rates do not remain static. They march up and down depending on economic conditions. The U.S. Federal Open Market Committee is responsible for meeting to determine whether the economy is reasonably strong or weak, which they do by analyzing economic data around the country. If it’s strong, they sometimes raise the rates to rein in inflation. If it’s weak, they may lower rates. lower rates.

All loans of any type can be divided into one of two categories: fixed rate and variable rate. Student loans are no different.

The term “fixed rate” means that the interest rate will be fixed throughout the life of the loan. In other words, if your interest rate is 6.85%, it will always be 6.85%, until the loan is paid off.

The term “variable rate” means that the interest rate will vary throughout the life of the loan. Initially, it may be 3.25%, but it could rise gradually to 12% or more.

This is important because it has payment amount implications. The higher the interest rate, the more money you will pay, both per month and over the life of the loan.

A fixed rate may be slightly more expensive, but your payment will always be the same. A variable rate might start out with a low payment, but your payments may increase over time, both monthly and over the life of the loan.

Federal Student Loans and Interest Rates

If you’ve completed the Free Application for Federal Student Aid (FAFSA) and been approved for a loan, you have a Federal student loan. Although the U.S. government grants and issues these, it’s important to know that they are serviced by private companies. You will receive bills from those private companies, such as Navient and Nelnet.

All Federal loans have fixed interest rates, so once you get a loan, your payment will not vary.

Interest rates on Federal student loans are set annually by Congress. The rate each year is based on the interest rates in existence that year. They are not based on your credit rating, earnings or ability to repay the loan.

But, because they are set each year, you may have a different interest rate than a sibling or cousin who received a Federal student loan several years ago. Because interest rates change year to year, they could be higher or lower.

There is one exception to this. The interest rates for Federal Perkins loans are always set at 5 percent.

One further wrinkle in Federal student loan rates is whether they are subsidized or unsubsidized. If they are subsidized, the Federal government pays the interest as long as you are still in school. If they are unsubsidized, they accrue while you’re in school. When the loan repayment period starts, that accrual is added to the principal. (Principal is the original amount borrowed.)

The addition of the accrual is called capitalization. It will make the amount of the loan you repay larger than the original principal amount your borrowed. In other words, if you borrowed $20,000 in an unsubsidized loan and $5,000 in interest accrues while you complete school, you will have a total of $25,000 to repay. In addition, of course, interest once you start to repay will be charged on $25,000, not $20,000.

Private Student Loans and Interest Rates

A number of lenders issue private loans, including Wells Fargo, Discover and Sallie Mae. Their interest rates are generally go higher than the Federal loans rate, in a range from 2.78 percent to 12.99 percent. Private lenders do take your credit score into account. It is one of the factors that affect the interest rate you’ll receive.

Private lenders can offer fixed or variable rate loans.

In general, the better your credit score, the lower the interest rate. Other factors that affect it include the term (number of years) of the loan, whether it is variable or fixed, your income, how much credit you have and the lender’s determination of ability to pay.

The effect of interest rates on your student loan is a complicated subject because loans themselves vary, as do interest rates, the amount of student loans you have, your lender and your credit rating. Use this as a guide to getting the best possible rate on your loan.

Cover Image Credit: Pexels

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