Low federal student loan interest rates could be coming to an end

BY Sydney LakeJune 09, 2021, 3:00 AM
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Interest rates on federal student loans for 2020–21 fell to their lowest point ever since the 2008 financial crisis, at only 2.75%—a bittersweet benefit from the COVID-19-related economic downturn. But a benchmark rate in the bond market is signaling higher rates are probably on the way.

Interest rates have already been going up; the yield on 10-year Treasury notes has risen from about 0.5% in 2020 to above 1.7% this year. The U.S. Treasury Department holds regular auctions of its securities, and one particular auction of 10-year notes—which happened on May 12—will be used to set federal student loan interest rates for July 2021 through June 2022.

Each year, Congress passes interest rates set by the Department of Education, the primary lender of student loans. The Department of Education uses bonds (in particular, the 10-year note) to fund these loans.

Last year, the 10-year yield at this key auction was 0.7%, and this year, the auction closed at nearly 1.7%. As a result, federal student loan interest rates could jump to approximately 3.7% starting on July 1, 2021, and this rate would be locked in until June 30, 2022.

“Even though there is that increase, [federal interest rates are] still at a very low point—one of the lowest points actually in 10 years,” says Alyssa Schaefer, chief experience officer of Laurel Road, a refinancing platform. Plus, federal student loan borrowers have had the option to freeze their payments during the pandemic.

“The Treasury auction by itself will not have any impact on people’s payments starting back up,” says Steve Muszynski, founder and CEO of Splash Financial, a student loan refinancing marketplace. “The optics is the question: Will the fact that interest rates are going up for students drive politicians to enact change?”

How student loan interest rates are set

Federal student loan interest rates haven’t always been set this way, says Cody Hounanian, director of programs at Student Debt Crisis, a nonprofit organization focused on ending student debt. During President Barack Obama’s administration, Congress had full discretion over the federal rates.

And here’s where sorting out interest rates on student loans gets more complicated: Most borrowers have a mix of federal and private loans, according to student loan experts. And interest rates for private loans are set by each lender, though it’s possible for borrowers to refinance if rates fall.

“Federal student loan borrowers still do not have a loan refinancing option, despite years of advocacy and legislative efforts to create a refinancing program,” Hounanian says. “That means that borrowers with high interest rates will never have a chance to lower their rate, and there is virtually no other type of loan that lacks a refinancing option.”

It’s a two-sided coin, however. While borrowers with federal student loans don’t have a refinancing option, borrowers with private loans did not get the same reprieve on loan payments during the pandemic.

Student loan payments restart in October

Tens of billions of dollars in interest on federal student loans have been canceled during the pandemic, Hounanian says. With payments waived until the end of September, the government will cancel an even larger amount of interest, he adds.

“My fear is that people are just going to go through mass levels of delinquency in the fall because they haven’t had to make loan payments in 18 months,” Muszynski says. “People over the next few months should look at their loans, understand what their interest rate is, and understand what their payment is going to be.”

Schaefer agrees: “Do your homework. Refinancing is certainly an option just given how low rates are right now across the board,” she says. “Start to think about how you may adjust your budget once these payments start kicking back in again.”

While there’s been talk about student loan debt cancellation, the budget for it was nixed in President Joe Biden’s recent proposal. While top congressional leadership has supported cancellation ranging from $10,000 to $50,000 per borrower, it is unsurprising to student loan experts that mass forgiveness hasn’t happened yet.

“Recent rhetoric would suggest that mass cancellation is unlikely from the federal government,” Muszynski says. “Obviously it’s still up in the air, but it was removed from President Biden’s budget.”