Interest rates on federal student loans set to increase for 2021-2022 school year

Federal interest rates on student loans are considerably lower than they were before. In fact, borrowers paid 6.80% on direct unsubsidized loans for the 2012-2013 school year, which seems unfathomable right now given our low rate environment.

For direct subsidized loans and direct unsubsidized loans for undergraduate students disbursed on or after July 1, 2020 and before July 1, 2021, the current rates are set at 2.75%. Meanwhile, graduate and professional students with direct unsubsidized loans pay 4.30%, and parents and graduate or professional students with Direct PLUS loans pay 5.30%.

Each year, May brings another change to federal student loan rates from July to June of the following year. Rates are announced in June based on the May Treasury auction, so we can know now what the rates will be.

The new rates for Subsidized Direct Loans, Unsubsidized Direct Loans and PLUS Direct Loans first disbursed on or after July 1, 2021 and before June 30, 2022 will be as follows:

  • Subsidized or unsubsidized direct undergraduate loans: 3.734%
  • Direct Unsubsidized Graduate Loans: 5.284%
  • Direct PLUS Loans: 6.284%

What do these new rates mean for you as a borrower? Maybe nothing, but it depends on the type of loan you have and other details of your situation.

What do rate hikes mean for borrowers?

If you already have federal student loans, this year’s new rates will not affect your student loan interest rate or your monthly payment. This is because federal student loans all come with a fixed interest rate, which means your interest rate and monthly payment never change.

You may feel like you’re being punished if you consolidate your federal student loans with a direct consolidation loan, but it won’t earn you a new interest rate either. Why? Direct consolidation loans use the weighted average of your existing interest rates to set your new rate, so they won’t penalize you interest if federal student loan rates increase for new borrowers.

Borrowers with federal student loans should also stay quiet for now, or at least not make any drastic moves. This is because the special forbearance period is in place for federal student loans due to COVID-19, and no payments are due until at least September 30, 2021. Interest is also set at 0% for federally held student loans, so you can skip payments without any interest accruing.

What about borrowers with private student loans?

If you have private student loans, changes to federal student loan rates will not affect your monthly payment or your loan repayment process. This is because private student loan rates are determined separately from federal student loan rates, most of which are pegged to the one-month or three-month LIBOR index, or the London Interbank Offered Rate. Some private student loan rates are also based on prime.

That being said, borrowers with variable rate private student loans can absolutely benefit when interest rates drop globally. When interest rates fall, variable rate monthly payments fall with them. Of course, the reverse is also true, and higher interest rates lead to higher monthly payments for the same loan amount.

What is the impact of interest rate changes

If you’re considering taking out federal student loans this year, you can expect to pay a bit more due to higher federal student loan rates. Since federal student loans all come with fixed interest rates, you lock in one rate for the term of your loan. Even though they are slightly higher, they are still very low.

And don’t fall for the myth that higher rates mean your loan servicing company makes more money on interest. Federal loan managers are paid per loannot based on the interest rate charged on the loan.

Federal student loans also come with an array of important consumer protections, including the possibility of deferral or forbearance, as well as the ability to repay your loans with an income-based repayment plan.

That being said, there are some situations where it might make sense to refinance federal student loans with a private lender – at least after September 30, 2021, when payments resume and interest begins to accrue.

For example, it may make sense to refinance federal student loans with a private lender if you have excellent credit and qualify for a much lower interest rate. This is especially true as lenders like College Ave offer refinance loans with fixed interest rates as low as 3.34% and variable rates as low as 3.24%. Remember that refinancing federal loans with a private lender means foregoing options such as income-based repayment plans or public service loan forgiveness (PSLF).

If you already have private student loans and the interest rates are lower than what you’re paying, it makes perfect sense to consider refinancing. After all, private student loans don’t have prepayment penalties, just like federal loans. This means you can refinance your private student loan into a new loan with a lower rate without having to pay a penalty for doing so. Just be sure to be careful and avoid hidden student loan fees that some lenders charge, like origination fees.

The essential

Federal interest rates on student loans have the potential to change every year, so this year’s move comes as no surprise. Not only that, but changes to federal student loan interest rates do not impact existing borrowers. If you already have federal student loans, your rate is currently fixed and will never change unless you take steps to refinance your loans.

Also be aware that there are options that allow you to keep the federal student loan you have while getting a lower monthly payment. For example, you can switch from a standard 10-year repayment plan on your loans to a gradual repayment plan or an extended repayment plan. You can also select an income-based plan like Pay As You Earn (PAYE), Revised Pay As You Earn (REPAYE), Income Based Repayment (IBR), or Income Contingent Repayment (ICR). These plans allow you to pay a percentage of your discretionary income for 20-25 years before canceling any remaining loan balance. If your income is low enough, the monthly payment on an income-driven repayment plan could be as low as $0.

By the way, it always makes sense to pay attention to interest rates on private student loans, including how they change over time. If rates are low enough or you have federal loans with higher than average rates (like Direct PLUS loans), refinancing federal loans with a private lender could result in thousands of dollars in savings.

Bernadine J. Perkins