If you’re a student taking out a loan for your education, you know that every penny counts. You want to borrow what you need, and not a dollar more, for the least amount of interest.
After all, the interest rate on your student loan could have a substantial impact on your total cost of borrowing and your monthly payment. Even a 2 percent interest rate difference on $30,000 worth of debt, which is less than the average student loan debt load for 2016 graduates, could save (or cost) you more than $3,500 over the lifetime of the loan.
While you may not be able to choose your interest rate, understanding how interest rates are set on federal and private student loans, interest rate types and other costs related to borrowing can help you make an informed decision about funding your education.
Interest Rates on Federal and Private Student Loans
Federal student loans offer the same interest rate to all eligible borrowers, regardless of their income or credit. Most federal student loans don’t even require a credit check. The one exception: Direct PLUS Loans for grad students or parents of undergrad students require a credit check to determine your eligibility, but your credit still doesn’t affect your interest rate.
Federal student loans always have a fixed rate, meaning it won’t change once the loan is disbursed. For loans disbursed on or after July 1, 2017, the rates are:
| Federal Student Loan Type | Borrowers | Interest Rate (for loans disbursed from July 1, 2017 to June 30, 2018) |
| Direct Subsidized Loans | Undergraduate students | 4.45 percent |
| Direct Unsubsidized Loans | Undergraduate students | 4.45 percent |
| Direct Unsubsidized Loans | Graduate or professional students | 6 percent |
| Direct PLUS Loans | Parents of students, and graduate or professional students | 7 percent |
| Perkins Loans | Undergraduate, graduate and professionals students with exceptional financial need | 5 percent (regardless of disbursement date) |
Source: U.S. Department of Education
You can also find the interest rates for federal student loans that were disbursed before July 1, 2017 online. For example, undergraduate Direct Subsidized Loans’ interest rates have ranged from 3.4 to 6.8 percent since July 2006. And in general, you’ll see that interest rates have risen over the past couple years but are still lower than they were from July 2006 to June 2010.
[Read: The Best Student Loan Consolidation Lenders of 2018.]
Private student loan lenders may offer different interest rate ranges, and the interest rate may vary.
“Private student loans function more like auto loans or personal loans, compared to federal student loans,” says Robert Farrington, founder of personal finance website The College Investor, in an email. “The biggest factors impacting your private student loan rate will be your credit score, income and the loan factors [such as amount and loan term]. Of course, the higher your income, the better your credit score and the shorter your loan term, the better your interest rate will be.”
For example, as of Jan. 15, Connext, which U.S. News named as one of the top private student loan lenders for its competitive interest rates, offers a $12,000 undergraduate 10-year fixed-rate loan with a 5.4 to 9.7 percent APR. The same loan amount may have a 6.89 to 10.76 percent APR for a 15-year term. For a variable-rate loan, the initial APR range is 3.35 to 10.31 percent for a 10-year loan or 5.56 to 10.89 percent for a 15-year loan.
The lowest advertised interest rate isn’t necessarily the rate you’ll receive, though. You may need a creditworthy co-signer to qualify for any private student loan, and the lowest rate could only be available to the most creditworthy applicants in select areas.
The U.S. Department of Education says that federal student loans often offer borrowers a lower interest rate than private student loans. And a 2017 report from LendEdu, an online student loan marketplace, found that the overall average interest rate on private student loans was 7.99 percent, compared with 4.45 to 7 percent for federal student loans.
Federal student loans offer other advantages as well. Adam S. Minsky, an attorney specializing in helping student loan borrowers, says via email, “Federal loans have a lot more flexibility than private loans, including generous deferments and forbearance options, income-driven repayment and loan forgiveness programs, which private loans typically don’t have. Federal loans also have stronger consumer protections, including a death and disability discharge, and the right to cure default.”
Who Determines Student Loan Interest Rates?
Federal student loans have uniform rates because Congress sets the interest rate on federal student loans. The rates are based on the interest rate for a 10-year Treasury note (determined during an auction every May) plus an add-on rate, which depends on the type of loan and whether it’s for an undergraduate or graduate student. The resulting federal student loan interest rates apply to federal loans that are disbursed from July 1 to June 30 of the following year.
[Read: Getting Student Loans Without a Co-Signer.]
Interest rates on private student loans can vary because there isn’t uniform regulation that dictates how lenders set their rates for individual borrowers. Even if you find two lenders that have the same advertised interest rate ranges, the rates you receive could be different because lenders use proprietary underwriting processes. It’s important to compare the rates private student loan lenders offer you, not just the ranges they advertise, before taking out a private student loan.
Additional Costs to Consider
While the interest rate on your loan may be one of the most important factors in your overall cost of borrowing, it’s not the only one to consider. There are other fees that could affect your APR, which is your actual cost of borrowing each year. A student loan’s APR takes into account the loan’s interest rate, fees, when you start to make full payments and when interest capitalizes.
Loan Fees
Lenders may charge an origination fee that’s equal to a portion of your loan amount. It’s often taken out of the money sent to you or your school. The loan fee is 1.066 percent for Direct Subsidized Loans and Direct Unsubsidized Loans disbursed from Oct. 1, 2017 to Sept. 30, 2018. It’s 4.264 percent for Direct PLUS Loans disbursed during that period. Federal Perkins loans don’t have fees, and private student lenders often don’t charge an origination fee.
Application Fees
Application fees aren’t common with private student loan lenders, but some may have a small fee. You can apply for government aid with the Free Application for Federal Student Aid, or FAFSA.
Capitalization
Capitalization is when the interest that accrued on your loan becomes part of your loan’s principal. Your interest rate only applies to the principal of your loan, so if your principal increases, your interest charges can increase as well.
With federal student loans, interest capitalizes at the end of your grace period, when your loan leaves a period of forbearance or deferment, or if you consolidate or refinance your loans.
If you have subsidized federal student loans, the Department of Education pays your interest while you’re in school at least half time, during the grace period and during deferment. You can ask your counselor what qualifies as half time at your school.
If you have unsubsidized federal loans, a subsidized loan in forbearance or a private student loan, interest may accrue when you don’t make full payments and then get capitalized once you start making full interest and principal payments.
[Read: The Best Private Student Loans of 2018.]
One way to avoid interest capitalization is to make interest payments while you’re in school, or during periods of deferment or forbearance. Federal and private student loans don’t have a prepayment penalty, so there’s no charge for making extra payments.
Interest Rate Discounts
There are several situations in which the interest rate on your student loan could change.
For one, you may be able to get a temporary interest rate reduction if you sign up for autopay and let the lender automatically deduct your monthly payment from your bank account. Federal direct loans offer a 0.25 percent interest rate reduction, and many private lenders offer a 0.25 to 0.5 percent interest rate reduction with autopay. Some private lenders also offer a permanent 0.25 to 0.5 interest rate reduction if you have a financial account with them when you take out a new student loan.
Variable-Rate Loans
Private lenders may also offer variable-rate student loans, which have an interest rate that combines an index rate and a margin rate. The margin rate can depend on the lender and your creditworthiness, and it won’t change after you take out the loan. However, the index rate may change over time.
For example, the index rate could be the three-month London Interbank Offered Rate, or Libor, which is the interest rate that a bank may pay to borrow money from another bank for three months. Your student loan’s variable rate may increase or decrease based on how the three-month Libor changes.
Refinancing Student Loans
You may be able to lower your interest rate by refinancing your federal or private student loans. To do so, you can apply for and take out a new private student loan, and your new lender will pay off the existing student loans you wish to refinance.
Your new loan’s interest rate could depend on the lender and your creditworthiness, so you may want to build a positive credit history, good credit score and have a well-paying job before considering refinancing. You may have to graduate with a degree to qualify. As with applying for a private student loan when attending school, you can compare student loan refinancing companies to find the lender that offers you the best interest rate and benefits.
If you’re eligible for a lower interest rate than you currently have, you may be able to decrease your monthly payments and save thousands of dollars over the lifetime of your loan. However, refinancing federal student loans through a private lender will make the loans ineligible for federal loan forgiveness programs and repayment plans, so it might not always be a good idea.
“For borrowers that currently have federal loans, there is a lot to consider,” Farrington says. “Will you need income-driven repayment any time during your loan repayment period? Do you qualify for any forgiveness program? If so, it might not make sense to refinance.” Though, he adds, “For existing private student loan borrowers, there’s less concern — shop around and get the best rate possible.”
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What Every Borrower Should Know About Student Loan Interest Rates originally appeared on usnews.com
