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Friday, September 2, 2016

The True Cost of College: Understanding Interest Rates for Federal and Private Student Loans

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When it comes to student loans – or any type of loan – the interest rate is the biggest factor in determining what the borrower will pay in the long run. However, because student loan interest rates do not remain steady over time, it can be difficult for borrowers to gauge how much they’ll end up paying over the standard repayment term of ten years.
Direct Subsidized and Unsubsidized student loans taken out between July 2013 and June 2014 had an interest rate of 3.86 percent, while loans taken out between July 2014 and June of 2015 will have a 4.66 percent rate. Although an increase of less than one percent may seem inconsequential, it can cause a student loan borrower to pay thousands of dollars more in the long run.

Federal vs. Private Loans

Determining whether increased interest rates will affect a borrower’s student debt depends on the type of loan. For a private student loan, the interest is calculated based on the risk the borrower presents to lenders based on his or her credit and financial history. Federal loan interest rates, on the other hand, are not affected by the borrowers’ financial history; all borrowers receive the same interest rate regardless of their repayment risk.
In 2013, legislators passed the Student Loan Certainty Act, which mandates that interest rates for new federal student loans remain fixed for the entire length of their terms. Unfortunately, student loans that were taken out before July 1, 2013, are exempt from this law. Although there have been calls made for student loan refinancing options to help pre-2013 borrowers obtain lower interest rates, Washington has not yet responded.
Private student loans can have either fixed or variable interest rates. Generally speaking, variable rate private loans begin with lower interest than fixed rate loans do. However, because variable interest rates change based on a separate financial measure that is impossible for the borrower to predict, those loans can end up costing much more than expected.

Rising Education Costs

According to New America’s Graduate Student Debt Review, the average debt of a college graduate rose from $40,209 in 2004 to $57,600 in 2012, putting borrowers under greater financial strain than ever before. And with the Congressional Budget Office (CBO) estimating that federal student loan interest rates could reach 7 percent by 2018, the cost of college will continue to increase.
Recent grads’ best course of action is to pursue lowering monthly payments and accrued interest through a more flexible plan. There are several free, online student loan calculators that can be used explore different options available to reduce the burden of student loan debt.
College-interested high schoolers and their parents, on the other hand, should take the time to understand variable and fixed interest rates and how it will most likely affect the total amount they will end up paying. Putting in the time to do the research will pay dividends in avoiding high interest rate costs.


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