In mid-December, the US Federal Reserve raised their interest rates for the first time in almost a decade. The good news is that the rate hike was small – only a quarter of a percentage point. But it could herald the start of more rate hikes in the future.
You might have noticed a lot of headlines at the time talking about the rate hike and how it would affect things like the economy and mortgage rates. If you’re a millennial encumbered by student loan debt and you don’t see yourself getting a mortgage anytime soon, you might have thought that it wouldn’t affect you.
Unfortunately, you might be wrong.
That’s because an increase in the Fed rate causes ripples through the economy and the lending system. I won’t bore you by telling you too much about the specifics of why this happens since other people have done it better. The important thing to know is that this rate trickles down over time until it starts to affect things like student loan interest rates which will affect borrowers in a number of different ways.
Here’s four ways you could be affected:
1. Current Federal Loans
I’ll start with the good news! If you primarily have federal student loans then the rate hike will likely have minimal impact on you. Most federal student loans have fixed interest rates, which means that the interest rate remains the same over the life of the loans so they won’t change in response to a rate hike.
However, if you have older federal Direct Loans taken out prior to 2006, there is a chance that your loans might be variable rate loans and you could see an increase in your interest rate in the coming years, especially if there are more rate hikes.
2. Future Student Loan Borrowers
If you’re still in school or you plan on going back to school in the future, the rate hike will potentially affect both your federal student loans and your private student loans. That’s because the federal government sets the fixed rate each year and this figure is tied to the 10 year Treasury yield which is affected the by the Federal Reserve’s rate. These changes will likely be minor for those completing their degrees in the next few years. However, if you’re waiting a few years before returning for graduate school, you could see yourself paying a few percentage points more in interest.
If you need to take out private loans to go to school, you’ll likely also feel the impact of the rate increase since many private loans are variable rate loans.
3. Private Variable Rate Loans
The rate hike will likely affect those with considerable amounts of private variable rate school loans the most. That’s because with variable rate loans the interest rate varies according to the London Interbank Offered Rate or the LIBOR. Basically, this is the benchmark that banks use to determine how much to lend each other and it’s an important factor in setting interest rates around the world. It increases when the Fed rate increases and those increases are passed along to variable rate student loan borrowers.
Despite the fact that the rate will likely cause changes – there is an argument to be made that private loans, even variable rate loans won’t be going up too quickly since lenders were aware for a long time that the Fed’s rate hike was coming and anticipated it by pricing it into their current and past rates. But only time will tell whether this is the case.
Since many people have consolidated their private and federal loans to get a lower interest rate, there are potentially many borrowers who are holding a significant amount of their student debt in private loans and many of those are variable rate loans.
If you have variable rate private loans, you shouldn’t start worrying too much about next month’s payment. The interest rate increase was relatively minor at a quarter of a percentage and it will take several months to a year before you’re likely to see any changes. However, if the interest rates keep rising, that would mean that over time you’ll likely be paying considerably more.
You also have some options to try to mitigate these increases. The first thing you might do is try to accelerate your payments towards the principal of your loan. By paying off more of the principal of your student loans before the rate hike starts affecting you, you’ll pay less interest overall.
The next thing you could do is to potentially refinance your variable rate student loans into a fixed rate student loan.
4. Refinancing Your Student Loans
There are a lot of reasons why people refinance student loans. It can make it easier and more straightforward to pay them back when you have them all in one place, for example. But the biggest reason that people refinance their loans is to get a lower rate. This allows you to pay back your loans more quickly or allows you to get a lower monthly payment. Either way, you save money overall on interest costs.
But the challenge when it comes to saving money when refinancing your loans is that many of those private student loans you would use to refinance with are variable student loans. Should the Fed Rate continue to rise, that would mean that your variable interest rate would continue to rise and could potentially eat up some or all of the savings that you could get by refinancing.
If you are potentially thinking about refinancing and consolidating your student loans, it could be a better decision to refinance your loans with a fixed rate loan rather than a variable rate loan. Variable rate loans can often be tempting because the banks generally offer you a lower initial interest rate on them. Because you’re sharing the risk of rate hikes with the banks by getting a variable rate loan, the bank doesn’t have to price that into the interest rate. But given that the Fed has indicated that there could be more rate hikes in the future, it might be better to be safe than sorry.
If you do intend to refinance and plan on doing so with fixed rate loans, you might want to do so sooner rather than later. If you act now, you can likely lock in a lower fixed rate.
Author: Dave Rathmanner
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