The Federal Reserve announced on December 16th that they would be raising the short-term interest rates for the first time since 2006. Specifically, they are raising the target range for the federal funds rate to 0.25-0.50%.
The Federal Open Market Committee took action because they saw notable improvement in the labor market conditions and because they expect inflation rates to rise. The Committee described the move as a vote of confidence for the United States’ economy.
What does this mean for federal student loan borrowers?
In the majority of cases, this increase in interest rates will not affect current student loan borrowers. All federal student loans first disbursed between July 1, 2006 and July 1, 2015 have fixed interest rates. This means that the interest rates stay constant throughout the life of the loan, no matter what action the Federal Reserve takes. If you have a federal loan that was disbursed before July 1, 2006, you should double-check to see if you have a variable or fixed interest rate. Currently, there is $1.27 trillion outstanding in the United States, and 93 percent, or $1.18 trillion, is from federal student loans.
Borrowers who took out federal loans before July 1, 2006 were often given variable interest rates. Because these rates are dependent on the market, they may increase slightly over the next few months. Borrowers with variable interest rates should expect their minimum monthly payment to increase as a result.
The Fed updates its rates for federal student loans every July 1st. This means that the next round of federal student loans will likely be affected by the recent federal interest rate bump. Whatever rate is determined for new federal student loans, it will still be fixed and will not change over the life of the loan.
What does this mean for private student loan borrowers?
Most private student loan lenders allow borrowers to choose between a fixed and variable interest rate when obtaining a new student loan or refinancing old loans. Similar to federal loans, only current borrowers with variable rates on their outstanding private student loans will be affected by the Fed’s interest rate hike.
Many private student loan variable rates are highly influenced by the London Interbank Offered Rate—or LIBOR for short. The LIBOR is the rate at which the world’s leading banks trade at, and it is closely tied to the Federal Reserve’s short-term interest rates. The Fed’s increase may cause an increase in LIBOR, which would therefore cause an increase in variable student loan rates.
Borrowers who have outstanding private loans with variable rates can expect to see their interest rates increase slightly. Furthermore, those who decide to take out a new private loan, or those who refinance to a new private loan, can expect to start with a slightly higher starting interest rate as compared to previous years.
It is important to know what type of interest rates your student loans have so you can plan accordingly. If you have variable rates, your monthly payment may increase, so you should incorporate this into your budget as well as adjust any automatic bill payments that you’ve set up. If you aren’t already, you may want to consider taking advantage of benefits that reduce your interest rate, such as signing up for automatic payments. Finally, refinancing your student loans may be beneficial. Not only does refinancing often provide borrowers with a lower interest rate but it also provides the option to switch to a more stable fixed rate.
Just because the Federal Reserve announced that they would increase interest rates does not mean it is necessarily time to panic. Janet Yellen, the Chair of the Federal Reserve, explained that the changes would be gradually introduced over the upcoming years. If you have student loans with variable interest rates, plan on how you can alter your budget to accommodate for increasing monthly payments, and consider refinancing to a fixed rate if you are not comfortable with the thought of additional increases.