Now that the Federal Reserve Has Decided to Raise Interest Rates, What Happens to Student Loans?

The Federal Reserve Board began a two-day meeting on Tuesday, December 16, 2015, to set U.S. monetary policy and possibly increase the influential Federal Funds Rate. At this meeting, Federal Reserve decided to increase interest rates by 0.25 percentage points, marking the first time rates have been raised in almost a decade. The Federal Reserve Board previously said that it might consider increasing interest rates after unemployment rates dropped below 6%. Unemployment rates have been below 6% since September 2014, according to the U.S. Bureau of Labor Statistics.

When the Federal Reserve Board increases the Federal Funds Rate, it typically does so in increments of 0.25 percentage points. A 0.25% increase in the interest rate won’t have a big impact on the typical borrower’s monthly student loan payment. For example, the monthly loan payment might increase by about $1.25 per $10,000 borrowed, assuming a 10-year repayment term.

But, this increase may mark the start of a series of interest rate hikes. The last time the Federal Reserve Board increased interest rates, it did so in a series of 17 quarter-point increases over a two-year period from June 2004 to June 2006. The cumulative 4.25% interest rate increase is enough to have a measurable impact on monthly student loan payments, about $75 per month (and $9,000 in total) on a 10-year repayment term for a borrower with $35,000 in student loan debt.

Although the Federal Funds Rate does not directly affect the cost of student loans, changes in the Federal Funds Rate leads to similar changes in other key interest rates, such as the LIBOR index rate, the Prime Lending Rate and the interest rates on U.S. Treasuries. The interest rates on federal and private student loans are based on these index rates.

Refinance Variable-Rate Loans

Borrowers who have fixed interest rates do not need to do anything, since the interest rates on their loans will not change for the duration of the loan.  For example, federal student loans have had fixed rates since July 1, 2006. So, borrowers whose federal student loans were first disbursed on or after July 1, 2006, have a fixed rate.  (Borrowers with older federal student loans which were first disbursed before July 1, 2006, have variable interest rates.  These variable rates are subject to increase if the interest rates increase.  Thus, borrowers   can lock in a fixed rate by consolidating federal student loans into the Federal Direct Consolidation loan program at www.StudentLoans.gov. Most borrowers who had variable-rate federal student loans previously consolidated them in 2005, when they were able to lock in historically low interest rates.)

However, borrowers who have federal student loans with variable interest rates may wish to refinance their variable-rate loans into fixed-rate loans, before interest rates start increasing too much. Variable rate loans will see interest rates increase, probably in the same increments as the Federal Reserve chooses to raise rates. Private student loan borrowers have either fixed or variable interest rates.

Borrowers can refinance both federal and private student loans into fixed-rate private loans at www.StudentLoanConsolidator.com. Lenders refinancing private student loans include Citizens Bank, CommonBond, Darien Rowayton Bank, LendKey, SoFi and Nelnet, among others.

The APR on a fixed-rate private student loan will generally be a few percentage points higher than the APR on a variable-rate private student loan. And a longer repayment term will usually require a higher fixed rate, since the lender’s cost of funds is likely to increase over time as the Federal Reserve Board increases interest rates.

Usually, if a borrower is out of school, has been employed for two or more years and has been managing his or her credit responsibly, the borrower may be able to qualify for a lower interest rate on a private consolidation loan. To get a good credit score, the borrower must make all loan payments on time, not just the student loan payments. A single late payment is all it takes to ruin an otherwise great credit score.

After this initial interest rate increase, the Federal Reserve Bank will monitor to discern any effect the rate increase has on the economy. If financial indicators and the job market remain robust, there is an expectation that rates will climb higher.

This initial interest rate increase and movement upward could then be a precursor to rising interest rates and offers an opportunity for borrowers to get out in front of a possible rising interest rate trend by refinancing or consolidating their variable rate student loans.

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