How to Take Advantage of Lower Interest Rates for Students and Parents
Over the course of a few weeks, the government’s COVID-19 assistance for federal student loans went from waiving interest on some student loans, to suspending payments for two months, to stopping payments for six months.
Loan servicers are scrambling to update their systems to reflect these changes.
In the wake of these changes, the U.S. Department of Education has provided guidance for parents and students here: https://studentaid.gov/announcements-events/coronavirus.
You can also find some valuable information about which loans qualify and how this might affect you as a current borrower of federal loans in this detailed Q&A at Money.com.
For current borrowers, stopping payments and deferring interest on federal loans may help.
If you have a private student loan, however, you aren’t guaranteed these benefits. You can contact your private lender and explain your financial situation as it relates to the pandemic—loss of job, pay cut, illness that meant you were unable to work.
Some private lenders are claiming to offer some form of help by reducing payments or suspending payments for a short period of time.
Will There Be Lower Interest Rates on Student Loans?
Back in March, the Federal Reserve announced emergency steps to help the economy recently as businesses across the country slowed or shut down due to the pandemic.
These moves involved cutting the short-term federal funds rate to between zero and 0.25%. The rate doesn’t directly affect borrowers who have already left school and are in repayment, but it does mean that parents and students planning to take out student loans for the upcoming academic year will get rates close to record lows.
Since interest rates on federal loans are fixed over the life of the loan and set each May, federal loan interest rates will be at a record low.
These rate cuts will most likely drive down private lender rates as well offering borrowers a unique opportunity to take advantage of extremely competitive rates by shopping around and comparing.
Can We Predict Student Loan Rates?
Federal student loan interest rates are fixed rates and are set each July 1 for loans disbursed July 1 to June 30.
The rate is based on the last 10-year Treasury Note auction in May, plus a margin.
As explained at SavingforCollege.com, “If interest rates on federal student loans were to be based on the March auction high yield, as opposed to the upcoming May auction, the predicted interest rates for 2020-2021 would be 2.899% on undergraduate Federal Direct Stafford Loans, 4.449% on graduate Federal Direct Stafford Loans and 5.449% on Federal Direct PLUS Loans. That’s 1.63% percentage points lower than the current 2019-2020 interest rates.”
It makes sense that interest rates are volatile right now.
If the outbreak continues, they could drop even lower; but, if it is under control in the next two months, interest rates could be higher than predicted.
Private student loan rates will also be affected as well.
How Can Borrowers Benefit From These Rate Changes?
If the rates remain low when the federal loan is disbursed, parents and students will be able to borrow at these lower rates.
Current federal student loans cannot be refinanced as new federal loans at the lower interest rate.
Older federal student loans cannot be refinanced as new federal loans to obtain a lower interest rate.
One option is to refinance your federal loan to a private student loan if the interest rate is lower. However, the interest rates on federal student loans are generally lower than the interest rates on private loans.
Also, important to note—if you switch to a private student lender, you lose the benefits of federal loans: death and disability discharges, longer deferments and forbearances, income-driven repayment plans and loan forgiveness options.
If you currently have a private student loan and a secure income, you have little to lose by refinancing.
With a good credit score and low debt-to-income ratio, lenders will be more willing to refinance.
With interest rates significantly lower, borrowers can get a lower interest rate with new repayment terms.
For those with federal loans, refinancing might not be the best option.
It is also crucial to keep in mind that the pandemic is causing the government to re-evaluate the financial outlook daily and we don’t know if the federal relief currently in place will be the last for student borrowers.
Different programs may be announced if the situation worsens and refinanced private loans may not qualify.
How Can the Interest Waiver Help Borrowers Save Money?
The loans impacted by the interest waiver include direct subsidized loans, direct unsubsidized loans, Parent and Graduate PLUS loans, and direct consolidation loans.
It also includes any Federal Family Education Loan (FFEL) program loans and Perkins loans that are currently federally held. No interest or payments on these loans can help if you are struggling financially.
If you are able to keep making payments on your student loans during this time, however, it makes good sense to keep doing so.
With no interest accruing on your loans during this period, you can actually get ahead by having a larger amount of your payment go toward your principal.
If more money goes toward your principal, you will pay off your student loan faster.
Should College Savers Opt for Student Loans?
Federal loan interest rates could fall below 3% for the first time in 15 years.
At the same time, parents may have lost money in their 529 savings plans due to the stock market’s response to the pandemic.
With this in mind, should savers consider taking out loans for college instead?
Ryan Lane of NerdWallet.com explains, in a recent article, how to tell if the strategy is right for you and your family:
- You have lost money—Consider taking federal student loans so you can stay invested long enough for your 529 to recover. Ideally, you will earn enough to negate any interest accruing on the loans as well.
- You would qualify for interest-free loans—If you qualify for a federal subsidized loan based on financial need and it is awarded in your financial aid package, accept it. These loans don’t charge interest while your student is in college.
- You can accept the risk—You are gambling that the market will improve, and you will have a good return on your investment. If you borrow, pay off the loan’s interest before it capitalizes, or it is added to your balance. Otherwise, the amount you repay will increase, cutting your potential profit.
- You have a non-parent 529—When calculating federal financial aid, withdrawals from such accounts count toward the student’s income, which is assessed at a higher rate. Students in this situation may want to opt for loans that can be paid off later with the 529.
- Your state won’t tax you—Some states tax 529 savings plan withdrawals used to pay student loans. Before making the decision to borrow, check with your state’s laws on 529s.
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