The cost of borrowing money for college in the United States just got a little bit cheaper.
The federal government lowered interest rates for student loans starting July 1. New rates for direct undergraduate loans are 4.53%, down from 5.05%. Graduate direct unsubsidized loans are 6.08%, down from 6.6% and Parent PLUS loans are 7.08%, down from 7.6%.
The average undergraduate will save $199 in borrowing costs during the next academic year, according to calculations by Credible.com, a marketplace for private student lenders. In aggregate with graduate and parent loans, that amounts to $3 billion in overall interest savings.
Unfortunately, this rate cut will not affect the estimated $1.6 trillion already owed in student debt, because the changed rates only apply only to new loans.
All this will come as news to many students who take out federal loans for college, even though it was announced months ago.
When families call financial aid expert Mark Kantrowitz for help, they often do not know their loan balance, servicer or interest rate.
“Students might have a subsidized federal loan and an unsubsidized loan each year, so that’s eight, maybe 12 if their parents also have loans, and managing that can be challenging,” said Kantrowitz, publisher and vice president of research at savingforcollege.com.
Federal student loans do not come with the same kind of disclosure documents as mortgages, which detail the interest rate, monthly payments and applicable rules for repayment. They do not even have the same rules as private student loans, which are required to provide rate disclosures.
“Financial award letters and net price calculators make it unclear how much you are borrowing, so it’s no wonder that students are in over their heads,” Kantrowitz said.
One risk of the lower rates is that students will think they can borrow more, but this could lead to risky borrowing.
“This is just for one year’s loans,” cautioned Kantrowitz. “Regardless of the interest rate, you’re still paying back principal.”
Another risk is that students may be tempted to refinance prior loans, especially if they see aggressively advertised low rates on the private market.
Even those in the private student loan business say that federal student loans are usually a better deal for undergraduate students, because there are more consumer protections and income-based repayment options along with no co-signing requirements.
For graduates and parents, the math might be different. If you are a parent with good credit, private rates are competitive, said Christine Roberts, head of student lending for Citizen’s Bank.
However, it is not always easy to compare borrowing options. The place to start is studentloans.gov, where you can see your federal loan information.
For those loans, families need to be aware that any listed interest rate also comes with fees, which would drive up the actual cost of borrowing. On the private loan side, your credit score or other underwriting factors could disqualify you for the advertised rates.
Simply knowing the difference between an interest rate and an annual percentage rate (APR), which rolls up all the costs of a loan, is important financial literacy, said Joel Frisch, head of Americas at Prodigy Finance, a UK-based firm that specializes in lending to international graduate students.
“If one loan is 6% with a 1% fee and one is 5% with 4% application fee, it’s really hard if you just look at interest rates,” Frisch said.
The bottom line is to take your time. “If you are taking on the debt of a small mortgage, take more than 60 seconds thinking about it,” Kantrowitz said.
A recent Duke University study showed that students who take the time to think about how much they are borrowing and what it is used for ended up taking thousands less in loans.
Duke is now in its second year of issuing a spring debt letter to each student, which details their loans and gives a ballpark estimate of what monthly payments will be after graduation.
“The first time we sent it out, we got two phone calls within the hour from concerned students,” said Irene Jasper, Duke’s director for the office of student loans and personal finance. “That was pretty cool.”
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