Earlier this year James Park noticed that the interest rate on one of his student loans for roughly $38,000 had almost doubled in three years — jumping from 2.4% to 4.23% during that period.
Park said he hadn't paid much attention to the rate hikes as they were happening because the monthly increases were relatively small. "I thought that I'd be safe for a while, but it kept rising," he said.
This spring, the 42-year-old lab scientist realized how much the rate had increased overall. He also knew that it was likely to keep going up. So Park decided to refinance his variable rate loan — or a loan with a rate that fluctuates — to one with a fixed rate. As he began to investigate his options, Park said to himself, "I better do this now before it keeps ballooning."
We're in a rising interest rate environment. After years of historically low interest rates, the Federal Reserve is gradually pushing up rates again. That has implications for student loans of all types, whose rates are based on metrics that are influenced by the Fed's decisions.
If Park's story sounds familiar — and you're watching your or your child's student-loan interest rate go up — we're here to tell you why it's happening and what you can do about it.
If you have a variable-rate loan, it's likely from a private lender
Student loans come in two interest rate types — variable and fixed. "Borrowers who have variable rate loans should get used to the likelihood that the rates will be changing," said Mark Kantrowitz, the publisher of Savingforcollege.com.
If you have a variable-rate loan, it's likely from a private lender. The federal government stopped making variable- rate student loans in 2006. Still, if you're taking out a new federal student loan this year, the rate will be higher than last year's due to the interest-rate environment.
If you're still paying back a loan from 2006 or earlier, it's possible you have a federal loan with a variable rate. The federal government changes the rates on its variable loans every year on July 1, so it's likely your rate ticked up recently.
Why is my rate rising by more than the Fed's latest rate hike?
Though student loans are influenced by the Fed's decisions, they aren't tied directly to them. Rates on private student loans are typically tied to the London Interbank Offered Rate, or Libor, or the 10-year Treasury yield. As those rates fluctuate, so too will the rate on your variable-rate student loan.
Lenders will typically add a margin to that rate, which they determine based on your credit score and the credit score of your co-signer if you have one, Kantrowitz said. Private lenders usually change rates on variable-rate loans monthly, quarterly or annually.
Rates on new federal student loans are tied to the 10-year Treasury auction in May. Rates on federal variable-rate loans are tied to the rate of the 91-day Treasury bill auctioned at the final auction held before June 1. In both cases, a margin is added to determine the student-loan interest rate. That margin is determined by law, which is occasionally amended by Congress.
My variable-rate loan is making me nervous — what can I do?
If you have a private variable-rate loan you can refinance it into a fixed-rate loan, which will have an interest rate based on your credit score and other factors. You may be able to lock in a rate that's lower than the one you have currently, said Stephen Dash, the chief executive officer of Credible, a platform that allows borrowers to compare loan offers from multiple lenders.
Dash said his company has seen increased interest in refinancing over the past 18 months, as borrowers have become concerned about the possibility of rising rates. "That gives people peace of mind that they've locked in their loan and it won't change," Dash said.
If you've been paying your loan on time, you may be able to convince your lender to switch your variable-rate loan to a fixed one without refinancing, Kantrowitz said. That route could simply be more convenient — you won't have to re- enter your bank information to have the money automatically debited from your account, for example — and you avoid switching to a new repayment term.
Your new fixed rate loans could be higher than your variable rate
But it's possible the new fixed rate will be higher than the rate on your variable loan, Kantrowitz said. "If you're capable of paying off the debt in full and are planning on doing so in the next few years, it may be worthwhile to stick with that variable rate," he said.
If you have a federal variable-rate loan, you may also be able to refinance it into a private, fixed-rate loan, but you'll lose many of the protections offered by the federal loan program, like the ability to pay back the debt as a percentage of your income, which can make paying off the loan less burdensome for people who don't have high-paying jobs.
You also have options within the federal loan program to get rid of your variable-rate loan. You can consolidate it into a Direct Loan — the only type of loan the federal government is currently issuing — is with a fixed interest rate.
But there are downsides, said Adam Minsky, a Boston-based lawyer. If you've made any progress towards loan forgiveness, consolidating into a new loan will restart the clock.