Federal student loans will be more expensive for the 2021-22 school year.
Interest rates for new undergraduate federal student loans will rise from 2.75% to 3.73% for 2021-22. The interest rates for undergraduate, graduate and PLUS loans are determined by results of the U.S. Treasury Department's May auction of 10-year notes, according to New America, a public policy think tank. The Treasury sells 10-year notes to raise money.
For Undergraduate loans, 2.05 percentage points will be added to the interest rate.
Interest rates for the 10-year notes plunged last year when investors aggressively sought the safety of federal debt as the coronavirus pandemic unfolded. As a result, federal student loan interest rates fell to a historic low in 2020.
The federal student loan interest rate is set by adding the interest rate on the May 10-year note, 1.68%, to margins set by Congress. Lawmakers vote on the margins each year and while these haven't yet been set for 2021-22, the margins aren't expected to change from last year.
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For undergraduate student loans, 2.05 percentage points will be added to the interest rate. For other loans, 3.6 points will be added for graduate student loans and 4.6 points to PLUS loans. Here are the higher rates for each type of federal student loan:
Interest rates for federal student loans are fixed through the duration of the loan, so loans taken out before July 1 will still have this academic year's 2.75% interest rate. Currently, under the first COVID-19 relief bill, federal student loan interest rates are at 0% and are in forbearance until October 2021.
Impact of the rise in interest rates
Borrowing $5,500 in federal loans for 2021-22 — the maximum loan amount for dependent first-year undergraduate students — for a standard 10-year term will cost $1,098 in interest with monthly payments of $55. That is $3 more a month and $301 more in total interest compared with the same loan taken out at this year's rates.
The increase in interest rates will have a bigger impact on borrowers who take out PLUS loans given the higher interest rates on such loans. There are also no specific limits on the amount of a loan; rather, it is determined by the school's cost of attendance.
If a parent borrows around the average for a PLUS loan, or $16,500, for a 10-year term at next year's rate of 6.28%, the cost would be $186 a month and $5,762 in total interest. That's $9 more a month and $969 more in total interest for the same loan this year.
Federal vs. private student loans
While federal student loan interest rates will increase next year, borrowers should still pursue and exhaust federal loans before turning to private lenders. Unlike private student loans, federal student loans don't require co-signers and all borrowers receive the same interest rate.
Interest rates on private student loans are typically higher than those on federal loans and depend on a borrower's credit history and term length. Private student loans aren't included in any student loan forgiveness programs and are excluded from the current pause on federal student loan payments.
But students shouldn't turn to loans until after they've filled out the Free Application for Federal Student Aid — the FAFSA — and heard back from their college about scholarships, grants and other aid that doesn't need to be repaid.
Article courtesy of Nerd Wallet written by Colin Beresford