It may seem like student loan interest rates are set by flinging darts at a board, but in fact there’s a set process each year for federal student loans. Since 2013, each type of loan– Direct Student Loan, Grad Student Loan and Parent PLUS loan– has a set markup from the 10 year Treasury yield at the May Treasury auction. That auction happened last week, so interest rates for loans issued for the coming school year are now set. The yield is 2.943%, an increase of more than 1% from last year’s 1.684% yield– which was also about 1% higher than the previous year– which means that interest rates will go up a comparable amount.
Here are the various loan types, markups and current vs prior year rates:
|Loan Type||Markup||2022-23 Rate||2021-22 Rate|
|Direct Undergraduate Loan||2.05||4.99%||3.73%|
|Parent PLUS Loan||4.6||7.54%||6.28%|
|Direct Graduate Loan||3.6||6.54%||5.28%|
What does it mean that the rate is going up? Federal student loans have fixed interest rates for their lifetime, so this means that any student loan taken out between July 1, 2022, and June 30, 2023, will have the above interest rate until it’s paid off. And any loan taken out for the current school year– loans taken out between July 1, 2021, and June 30, 2022– will continue to have last year’s interest rate.
It does mean that borrowers will pay more. A first-year student who took out the maximum $5,500 unsubsidized loan last year and never made payments during college would have monthly payments of $63.24 per month for 10 years. A first-year student with the same loan this year would pay $69.96 per month. Which is only $6.71 per month, but it’s also 12 x 10 x $6.71 = $805 more over the lifetime of the loan.
What else does it mean? Interest rates on all loan types are going up, including private student loans. One major difference between federal student loans and private student loans is that all federal loans have fixed interest rates– rates that don’t change– whereas many private loans have variable interest rates that change based on changes to underlying interest rates. In a rising interest rate environment such as right now, variable rate loans can have disastrous consequences because payments increase as interest rates increase and more of every dollar of repayment goes to interest and less to principal.
A rising senior who took out student loans each year would have the following interest rates:
- First year (2019-2020): 4.529%
- Second year (2020-2021): 2.75%
- Third year (2021-2022): 3.734%
- Fourth year (2022-2023): 4.99%
This provides an excellent framework for thinking about whether consolidating student loans for repayment makes sense. Borrowers who consolidate get a blended rate based on the average rate of the balances, rounded up to the nearest 1/8 of 1%, and then make a single payment each month. In this case, the blended rate would be 4.125%– about 0.1% higher than the individual rates. This translates into an extra $2 per month in payments, or a total cost of $240 over the lifetime of the loan, assuming the borrower makes the minimum monthly payment each month for 10 years.
What if you make extra payments? A borrower paying an extra $100 per month on the 4.99% loan would save over $1,300 in interest over the lifetime of the loan and have that loan paid off after four years, at which time they could direct $183 per month– the extra $100 plus the 4.99% loan’s monthly payment– towards the next-highest-rate loan. Making the same extra payment at the blended rate of 4.125% would only save $1,000; making the extra payment on the loan at 2.75% would only save $371 in interest. So borrowers who might be able to pay extra– whether every month or periodically– also save more by being able to target higher interest rate loans first.
Of course, with higher interest rates students should also be mindful of limiting borrowing to the extent possible. A student who’s able to earn extra money this summer would do themselves a service to use that money to reduce next year’s loans.