It’s looking good for new borrowers who are on track to save $2.9 billion in interest.
Students looking to attend college this fall will be be able to apply for federal loans at lower interest rates as of July 1, 2019. The interest rates for new borrowers is set to drop by five-tenths of a percentage point.
This is the first interest rate reduction for federal student loans in three years, and only came about from falling bond yields which allowed the government to take out cheaper loans. For borrowers taking out PLUS loans, the average savings will range from $199 for undergraduates to $805 for graduate students.
Breaking Down The Savings
The revised federal student loan interest rates and their savings are as follows:
- Undergraduates: 4.53%, average savings of $199 based on average annual borrowing of $6,570.
- Graduate students: 6.08%, with an average savings of $596 based on annual borrowing of $18,860.
- Parent PLUS loans: 7.08%, saving an average of $805 on annual borrowing of $24,810.
These savings from the lower interest rates will affect grad students and parent PLUS borrowers the most. This is because they pay higher interest rates and take out larger loans.
It is self-explanatory that undergrads will claim the largest share of the $2.9 billion in savings, as they are the largest group of borrowers. An estimated 6.5 million undergraduates will save $1.3 billion, and roughly 1.4 million grad students will save $1.2 billion. The remaining $416 million in savings will be claimed by the 779,000 families who take out parent PLUS loans every year.
Of course these savings estimates are based off the assumption that borrowers will begin repaying their loans immediately. In practice this is different as a growing number of borrowers are taking more time to pay off their loans in income-driven repayment (IDR) plans.
How Interest Rates are Set
Once a borrower takes out a federal student loan, the interest rate is fixed for the duration of the loan. But the interest rate offered changes annually at the behest of Congress, and is tied to the cost of borrowing for the government.
The Department of Education sets the annual interest rate based off these parameters:
- Undergraduate loans: 10 year Treasury yield plus 2.05 percentage points.
- Graduate loans: 10 year Treasury yield plus 3.6 percentage points.
- Parent PLUS loans: 10 year Treasury yield plus 4.6 percentage points.
No matter the yields, Congress has set limits to cap the interest rate at 8.25% for undergraduates, 9.5% for graduate students, and 10.5% for PLUS loans.
The Federal Reserve hiked interest rates four times last year, but their influence is curbed over long term rates which is driven by demand for Treasury notes and mortgage-backed securities. When investors switch from buying stocks to bonds, long term interest rates gets pushed down.
As a new borrower, it will be good to check what rates you can qualify for this coming academic year. Take note that federal loans also offer borrower protections like access to IDRs and public service loan forgiveness. And if you need any other financial advice, the Financial Helpers are here to assist you.