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What looming interest rate hikes mean for student loan borrowers

Federal Reserve Chairman Jerome H. Powell suggested on Tuesday that the Fed may soon raise interest rates to fight rising inflation.

“If we see inflation persist at high levels for longer than expected, if we have to raise interest rates further over time, we will,” Mr Powell said Tuesday at a hearing of the Commission. Senate Banking Commission. “We will use our tools to recover inflation.” Fed officials had previously suggested that there could be several interest rate hikes in 2022 in an attempt to slow historic inflation levels.

Here’s how impending interest rate increases can impact student loan borrowers.

Most Federal Student Loan Interest Rates Stay At Zero Due To Pause In Payments – For Now

All federal student loans held by the government have been on a payment break and interest suspension since March 2020. For almost two years, no payments have been due on these loans and interest rates have been frozen at 0%. This relief was originally scheduled to end on January 31, but last month President Biden extended the relief until May 1.

Any interest rate hike by the Fed will have no impact on the interest suspension associated with this ongoing payment break.

Federal student loan interest rates are set by Congress

Congress sets federal student loan interest rates through legislation, which it updates periodically. The interest rate on most federal student loans is set at a specific rate based on the date the loan was disbursed, and the interest rate does not (and cannot be changed) afterwards. . For example, the current interest rates for Federal Direct Stafford student loans paid on or after July 1, 2021 and before July 1, 2022 are 3.73% for undergraduates and 5.28% for students. graduates or professionals. Loans disbursed during that 12-month period would be set at these rates, regardless of what the Fed does in the future.

Federal consolidation loan interest rates are generally set at the weighted average of the underlying loans included in the consolidation.

Once the student loan suspension and interest freeze expires after May 1, federal student loan interest rates will revert to the rates that were previously in effect, based on the fixed rate associated with the disbursement date. initial loan. Any change in interest rates by the Fed would have no impact.

The interest rates for private student loans are set by contract

Unlike federal student loans, the interest rates for private student loans are set by the terms and conditions of the underlying loan agreement or promissory note. The contract could provide for a fixed or variable interest rate. The fixed rates would not change no matter what action the Fed takes, as these interest rates are set according to the original terms of the contract.

However, some private student loans with variable interest rates could be tied, directly or indirectly, to the rates set by the Fed. As a result, borrowers on private variable rate student loans may see their interest rates gradually rise as Fed institute rates rise. Additionally, interest rates on new private student loans – both fixed rate and variable rate loans – could also gradually increase in line with interest rate hikes instituted by the Fed.

Borrowers with high interest rate private student loans – and especially those with variable rate private student loans – may consider taking advantage of the current low interest rate environment by refinancing these loans at means of a new loan at low fixed rate, before interest rate. hikes occur. However, borrowers with federal student loans should be more careful, as refinancing federal student loans through a private lender results in a permanent loss of access to key federal student loan programs, benefits, and protections.

Biden administration considers interest relief on student loans

Last year, a rulemaking committee negotiated by the Department of Education tasked with reviewing regulations governing major federal student loan programs reached consensus on changes to interest capitalization student loans. Funding occurs when current accrued interest is added back to the loan principal, which can lead to increases in the compound balance.

The regulatory committee and the ministry came to an agreement to eliminate certain events that may lead to interest capitalization, such as abandoning a forbearance, changing a repayment plan, failing to recertify income on time for a repayment plan based on income and default. These proposed changes – which would not become final and effective until July 2023 – would not affect the interest rate on a federal student loan, but instead help reduce the uncontrolled increases in the balance associated with accrued interest. .

Further reading on student loans

3 big takeaways from Biden’s surprise extension of student loan relief

Student loan interest: agreement reached to limit certain uncontrollable increases in balance

$ 2.4 billion in student loan forgiveness for 38,000 borrowers in preparation, education ministry says

Biden Should Forgo Student Loan Interest If He Does Not Extend Payment Break, Senators Say