The Federal Reserve Board began a two-day meeting on Wednesday, September 16, 2015, to set U.S. monetary policy and possibly increase the influential Federal Funds Rate. Even if the Federal Reserve does not increase interest rates at this meeting, it is likely to do so before the end of 2015. 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 increases. 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 example, federal student loans have had fixed rates since July 1, 2006. (Borrowers with older federal student loans that have variable interest rates can lock in a fixed rate by consolidating the loans into the 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 loans with variable interest rates may wish to refinance their variable-rate loans into fixed-rate loans, before interest rates start increasing too much. Most private student loan borrowers have variable interest rates. Borrowers can refinance private student loans into fixed-rate private student loans at www.StudentLoanConsolidator.com. Lenders refinancing private student loans include Citizens Bank, CommonBond, Darien Rowayton Bank, Earnest,LendKey, SoFi, and Wells Fargo, among others.
The interest rate on a fixed-rate private student loan will generally be a few percentage points higher than the interest rate on a variable-rate private student loan, because the fixed interest rate takes into account the assumption that prevailing interest rates will increase.
Fixed-rate private student loans tend to have shorter repayment terms, to keep the fixed interest rate from being too much higher than the corresponding variable rate. A longer repayment term will 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.
If a borrower is several years beyond his or her college graduation 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 because of improvements in the borrower’s credit scores. 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.