Starting in this upcoming school year, student loan interest rates will drop to the lowest levels they have seen in at least a decade.
Beginning in the 2016-17 academic year, the interest rate on the federal loans taken out by undergraduate students to help them pay for college will drop from 4.29% to 3.76%. Graduate students will see a drop from 5.84% to 5.31%. Parents who take out federal loans in order to pay for schooling for their children will also see a drop in interest rates on the PLUS loan, going from 6.84% to 6.31%. Interest rates for these loans are fixed for the lifetime of the loan, meaning that if the rates increase in the future, students who take out loans this year will be locked into the lower rates.
"Cheaper debt clearly aids repayment for students who don't enroll in any of the income-driven repayment options," said Carlo Salerno, an education economist and private consultant. "It makes monthly payments lower in relative terms, but it also makes the total cost of the loan — principal plus all interest paid– less too."
The rates will only apply to those loans taken out for the 2016-17 academic year. It is unknown what the rates will do the following year, although one projection from the Congressional Budget Office suggests that rates could go above 6% for undergraduate loans, 7.5% for graduate loans, and 8.5% for PLUS loans by 2018, writes Danielle Douglas-Gabriel for The Washington Post.
Caps exist on the loan rates in order to ensure that they do not increase to too high a level. Undergraduate loans cannot go above 8.25%, graduate loans cannot exceed 9.5%, and the cap on PLUS loans is 10.5%.
"While market-based interest rates are a far better solution than the structure they replaced, they still suffer from a key problem," Salerno said. "Where borrowers enroll, what program they choose and whether they complete [college] all affect the employment and income opportunity they'll have later on that will determine their ability to pay back those loans."
The interest rate for federal student loans was determined by the recent auction of the 10-year Treasury note before June 1. The interest rate for federal student loans had previously been set by Congress, until 2013 when lawmakers decided to change the policy to link the rate to the Treasury note, as the previous method continuously resulted in Democrats pushing for the investment of more money into the creation of a fixed, low rate, while Republicans argued that rates should be connected to the market.
That standoff resulted in an interest rate of 6.8% in 2013. Eventually, the two sides came to an agreement that interest rates would be tied to the market, setting caps to ensure that could not increase too high in case the economy took a downturn.
Undergraduates who took out loans in the years since the deal had been put in place would have paid an additional estimated $51.5 billion in interest payments over the course of their loans, writes Lauren Camera for US News.
Overall, the amount saved by a borrower depends on the type of loan taken out, the amount of the loan, and the length of repayment.