As a derivative impact of the coronavirus pandemic, students borrowing for college will benefit from some of the lowest interest rates on record for federal student loans this upcoming school year. Federal student loan rates for the period starting July 1, 2020, to June 30, 2021, are at a decade low 2.75%. Should one take advantage?
How are Student Loan Interest Rates Determined
Since 2013, federal student loan interest rates are set each year based on the 10-year Treasury note rate following the May 10-year Treasury notes auction (which was 0.70% for 2020-21).
The Department of Education uses the following formulas:
- Undergraduate Direct Loans: 10-year Treasury yield plus add-on of 2.05%
- Graduate Direct Loans: 10-year Treasury yield plus 3.6%
- Parent and Grad PLUS loans: 10-year Treasury yield plus 4.6%
Rates are fixed for the life of the loan, although rates for new loans are set each year.
Due to the pandemic and resultant turmoil in the economy, interest rates have fallen to record low levels. As a result, the interest rate that will be charged for student loans this fall is going to be the lowest in a decade.
It’s important to note that these rates are only for loans that originate after July 1, 2020. If you have existing loans, your rate on that loan is locked based on when you took out your student loan.
2020-2021 New Federal Student Loan Rates
Based on the 10-year Treasury auction, we will see the following rates for the 2020-2021 year:
- Undergraduate Direct Loans: 2.75%
- Graduate Direct Loans: 4.30%
- Graduate and Parent PLUS Loans: 5.30%
What About Private Student Loans?
These rates are for federal student loans. Private student loans already follow the 10-year treasury note pretty closely, but they also take into account borrower ability to repay, creditworthiness, and more.
If you have private student loans, now could be a good time to refinance, if you qualify. Rates are near historic lows for highly qualified borrowers.
However, it rarely makes sense to refinance a federal student loan into a private loan. By doing so, you would give up options like income-driven repayment, loan forgiveness, and your current COVID-19 forbearance and 0% interest.
How much money can I borrow in federal student loans?
It depends on whether you’re an undergraduate student, a graduate or professional student, or a parent.
- If you are an undergraduate student, the maximum amount you can borrow each year in Direct Subsidized Loans and Direct Unsubsidized Loans ranges from $5,500 to $12,500 per year, depending on what year you are in school and your dependency status.
- If you are a graduate or professional student, you can borrow up to $20,500 each year in Direct Unsubsidized Loans. Direct PLUS Loans can also be used for the remainder of your college costs, as determined by your school, not covered by other financial aid.
- If you are a parent of a dependent undergraduate student, you can receive a Direct PLUS Loan for the remainder of your child’s college costs, as determined by his or her school, not covered by other financial aid.
How do I get a federal student loan?
To apply for a federal student loan, you must first complete and submit a Free Application for Federal Student Aid. Based on the results of your FAFSA form, your college or career school will send you a financial aid offer, which may include federal student loans. Your school will tell you how to accept all or a part of the loan.
Student Loan Interest Rates
Your student loan interest starts accruing the day you take out your loan. If you received Direct Subsidized Loans, the federal government pays your interest while you’re in school and during the six-month grace period after you leave.
*** If you qualify for a Direct Subsidized Loan its a no-brainer to take advantage of the loan ***
But once that grace period is over, you become responsible for paying back both the principal and interest.
If you took out Direct Unsubsidized Loans, Direct PLUS Loans, or private student loans, interest accrues unpaid while you’re in school. If you don’t make interest-only payments, the accrued interest capitalizes and is added to your principal balance.
Going forward as you make payments, your student loan servicer will require you to pay off any late fees and accrued interest before applying any part of your payment to your principal balance.
Here’s how your interest gets calculated:
Interest Rate x Current Principal Balance ÷ Number of Days in the Year
= Daily Interest
As an example, let’s say your current balance is $20,000 and your interest rate is 4.30%.
$20,000 X 4.30% ÷ 365 = $2.36 a day
If you start paying the loan after 4 years you would have accumulated $3,445.60 of interest, which would be added to the principal taking the loan balance to $23,445.60 on which the interest of 4.30% would now be applied.
Let’s take another example of Peter who is an undergraduate student and takes out the Direct Unsubsidized Loan for the maximum allowable amount of $12,500 per year. Let’s assume 2.75% interest rate for the next 4 and a half years as interest accrues on the loan. At the end of 4.5 years if Peter doesn’t make any payments towards his student loan he would have accumulated Student Debt of $54,259.34.
|Year||Loan Amount||Balance||Interest Rate||Daily Interest|
|2024 (6 months)||$53,533||$54,259.34||2.75%||$4.03|
So it’s highly advisable to pay down the interest as it accrues on a Direct unsubsidized loan vs. a subsidized loan or one could get trapped into paying interest on the accumulated interest and a ballooning loan balance.5