How Does the Federal Reserve Rate Affect Student Loans?
In the very beginning of 2016, the Federal Reserve announced a quarter point change in interest rates. If you already have a student loan or you’re about to apply for one, you may be wondering about the way in which this legislative change is going to affect repayment rates.
For some students, the interest rate change is going to have no impact whatsoever. Others, however, should expect to see a gradual increase in the interest rate of their student loan.
The Federal Reserve Decision
This is the first interest rate increase since 2006 that the Federal Reserve has announced. The announcement is for a gradual increase by 25 basis points. In the very beginning, this will add up to 0.25 per cent. Gradually, this number will increase to 0.5 per cent.
Needless to say, this rate has an impact on the interest rate that banks introduce for their loans.
JPMorgan Chase, Wells Fargo and US Bancorp were the first financial institutions to announce an increase in their primary interest rate as a consequence of the Federal Reserve decision. The announcement came literally minutes within the Federal Reserve presented the news.
US Bancorp, for example, announced that the primary interest rate will go up from 3.25 to 3.5 per cent. A small change, which however has gotten some borrowers worried about their finances.
How will Student Loans be Affected?
Now on to the big question – what happens to student loan borrowers and the amount of money that they have to give back?
Most borrowers, like the individuals that have a federal loan, aren’t going to see any change in the conditions or the interest rate. The federal student loans come with a fixed rate and as such, they can’t fluctuate in the way that variable interest rate loans do.
Nearly 93 per cent of the student loans handed out are federal loans. This means that the overwhelming majority of students isn’t going to have to pay back more money because of the Federal Reserve decision. Congress sets federal loan rates and unless Congress decided to amend its prior decision, the Federal Reserve announcement isn’t going to contribute to making loans more expensive.
Variable rates are the problematic ones. A small portion of the federal loans (paid before July 2006) and the loans provided by other financial institutions may come with a variable rate. This means that the loan provider is free to change the interest percentage periodically.
Variable rate student loans are seen as more attractive because they typically come with better conditions than fixed rate loans provided by banks. The reason for the difference is easy to understand – variable interest rate loans come with a bit of uncertainty, which is why they have to be more lucrative for the borrower.
Still, analysts predict that the variable rate loans will continue to be more attractive than the fixed interest rate loans, even after the adjustments made following the Federal Reserve decision.
Loan Consolidation and Interest Rates
Recently, many financial institutions have come up with attractive offers that have prompted many students to give up their federal loans.
These loan consolidation offers come with very attractive interest rates. One thing to keep in mind, however, is that the interest rates are variable. As a result, students that decide to consolidate their federal loans and opt for borrowing from a private institution may find themselves at a disadvantage.
The federal government doesn’t provide loan refinancing options. This is the main reason why such consolidation products have gained a lot of popularity lately. In an attempt to increase their market share, banks offer favourable interest rates. The agreement, however, gives the financial institution an opportunity to modify that original interest rate periodically.
If you’re about to do loan consolidation or you’re considering any other refinancing option, it’s a good idea to consult an advisor. Go through the agreement carefully. A variable interest rate and a long repayment period mean that you’ll end up spending more money on your loan than originally planned.
The increase in interest rate stemming from the Federal Reserve decision isn’t going to be a dramatic one. Don’t expect your loan to become more expensive by a couple of per cent all of the sudden. Still, it’s a good idea to consider the fixed rate funding options and to postpone consolidating federal loans until you get a better idea about the impact of the change on interest rates in the longer term.