What the impending Fed rate hikes mean for borrowers

Federal Reserve Chairman Jerome H. Powell suggested on Tuesday that the Fed may soon raise interest rates to combat rising inflation.

“If we see inflation persisting at high levels for longer than expected, if we need to raise interest rates more over time, we will,” Powell told a committee hearing on Tuesday. Banking Senate. “We will use our tools to bring down inflation.” Fed officials had previously suggested there could be several interest rate hikes in 2022 in a bid to cool historic inflation levels.

Here’s how impending interest rate increases could impact student borrowers.

Most Federal Student Loan Interest Rates Remain at Zero Due to Pausing Payments — For Now

All federal student loans held by the government have been on payment pause and interest suspension since March 2020. For nearly two years, no payments have been due on these loans and interest rates have been frozen at 0 %. That relief was originally scheduled to end on January 31, but last month President Biden extended that relief until May 1.

Any increase in interest rates by the Fed will have no impact on the suspension of interest associated with this ongoing payment pause.

Federal student loan interest rates are set by Congress

Congress establishes federal student loan interest rates through legislation, which it updates periodically. The interest rate for most federal student loans is set at a specific rate based on the date the loan was disbursed, and the interest rate does not change (and cannot be changed) thereafter. . For example, the current interest rates for Federal Direct Stafford student loans disbursed on or after July 1, 2021 and before July 1, 2022 are 3.73% for undergraduates and 5.28% for college students. graduates or professionals. Loans that are disbursed during this 12 month period would be fixed at these rates, regardless of what the Fed does in the future.

Federal consolidation loan interest rates are generally set at the weighted average of the underlying loans included in the consolidation.

Once the current student loan payment suspension and interest freeze expires after May 1, federal student loan interest rates will revert to the rates that were previously in effect, based on the associated fixed rate. on the original disbursement date of the loan. Any changes to interest rates by the Fed would have no impact.

Private student loan interest rates are set by contract

Unlike federal student loans, private student loan interest rates are set by the terms and conditions of the underlying loan agreement or promissory note. The contract may provide for a fixed or variable interest rate. Fixed rates would not change regardless of any action taken by the Fed, as these interest rates are set according to the original terms of the contract.

However, some private student loans with variable interest rates could be linked, directly or indirectly, to the rates set by the Fed. As a result, borrowers with variable-rate private student loans could see their interest rates gradually increase as the Fed institutes rate hikes. In addition, interest rates on new private student loans – both fixed and variable rate loans – could also gradually increase depending on interest rate hikes instituted by the Fed.

Borrowers with high-interest private student loans – and particularly those with variable-rate private student loans – may consider taking advantage of the current low interest rate environment by refinancing these loans at means of a new loan at a low fixed rate, before interest rates. hikes happen. Borrowers with federal student loans should be more cautious, however, because refinancing federal student loans through a private lender comes with a permanent loss of access to key federal student loan programs, benefits, and protections. students.

Biden administration considering interest relief on student loans

Last year, a rules-making committee brokered by the Department of Education tasked with revising regulations governing major federal student loan programs reached consensus on making changes to the capitalization of interest on student loans. Compounding occurs when outstanding accrued interest is added to the principal of the loan, which can cause the compound balance to increase.

The Regulatory Committee and the Ministry have reached an agreement to eliminate certain events that may lead to capitalization of interest, such as abandonment of forbearance, modification of a repayment plan, failure to recertify income on time for a repayment plan based on income and default. These proposed changes — which would not become final and effective until July 2023 — would not affect the interest rate on a federal student loan, but instead would help limit the uncontrolled increases in the balance associated with the accrual of interest.

Further Reading on Student Loans

3 big takeaways from Biden’s surprise extension of student loan relief

Interest on student loans: agreement reached to limit certain uncontrollable balance increases

$2.4 billion in student loan forgiveness for 38,000 borrowers in the pipeline, Education Department says

Biden should forgo student loan interest if he doesn’t extend payment break, senators say