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Federal student loan interest just dropped to its lowest rate ever.
The interest rate for undergraduate student loans disbursed after July 1 is 2.75%. It’s an almost 40% decrease from last year’s rate for 2019-20 loans, which was 4.53%. Graduate and PLUS loan interest rates are also at record lows: 4.30% and 5.30%, respectively.
A lower interest rate means this year’s student borrowers will pay less overall for those loans. Here’s how loan repayment with last year’s rate compares with repayment with this year’s rate:
For $5,500 in undergraduate loans — the maximum a freshman can borrow — disbursed last year at 4.53%, the monthly payment is $57, with $1,350 in interest over the typical 10-year life of the loan. That same loan disbursed today costs $52 a month and $797 in lifetime interest. That’s $553 in savings.
The lower rates offer even greater potential savings to graduate and PLUS loan borrowers, who can borrow much higher amounts.
For $20,500 in graduate loans at last year’s rate — 6.08% — the monthly payments are $228 and total interest costs are $6,910. This year, that loan costs $210 a month, with $4,759 in interest — which is essentially a $2,151 discount.
Existing loans don’t get the new low rate
The lower interest rate applies to new loans only. Jan Miller, president of Miller Student Loan Consulting LLC, says many borrowers mistakenly assume their existing loans adjust to the latest rate each year.
Student loan interest rates are fixed based on the year a loan is disbursed. So only undergraduate loans taken out for the 2020-21 academic year will have a 2.75% rate. Existing loans will retain the rate associated with the disbursement year.
Student loans for the 2020-21 school year are unaffected by current student loan relief measures outlined in the coronavirus relief package.
Private loans are also cheaper
Private student loan interest rates are also trending down. Unlike federal student loan rates, private loan rates depend on a borrower's creditworthiness and can vary greatly between lenders. For the best qualified borrowers, many lenders are now offering rates near 1%.
Many interest rates for student loan refinancing have fallen as well. Graduates can take advantage of low refinance rates to reduce interest and payments on existing debt. They'll typically need a credit score in the high 600s, a low debt-to-income ratio — below 50% — and steady income to qualify.
While lower rates make it a good time to refinance private student loans, don’t refinance federal student loan debt yet. All federal student loans are in an interest-free administrative forbearance until Sept. 30, 2020.
Borrow only what you need
Don’t overborrow just because the rates are low. Base borrowing on college costs and expected future earnings.
Stephanie Hancock, a certified financial planner and owner of College Aid Consulting, advises borrowers to consider the current economic uncertainty, which contributed to the rate drop. "In this environment, do people want to take on additional debt?" she asks.
Miller also cautions against taking student loans if they weren’t previously in a student's financial strategy.
"I hope people aren’t changing their plans based on the rates," he says. "Debt is a great instrument, but it should be a last resort in many ways."