You have enough to worry about where your student loans are concerned. Rate hikes are the last thing you need to deal with right now. Yet, in December 2016 the Fed implemented an increase in interest rates. This is a decision many analysts had expected would come to pass.
That’s after a marked upswing in the nation’s employment rates had demonstrated the economy was healthy enough to see a rise in rates. This uptick in economic prosperity is certainly encouraging. However, it also continues on a steady track of progress that saw a similar increase just a year prior. As a result, you might find your bottom line affected with respect to repaying your student loans.
When the Fed talks, people listen. That is because a raise in rates can represent a dramatic impact on everything, from your credit cards to mortgage rates to, yes, student loans. Consumers have a lot to think about as interest rates rise and fall because of how those rates dictate how much it will cost to buy things, borrow money, and carry a balance on your credit cards.
Who is the Fed, exactly, and why do they get to make all these decisions anyway? Better yet, what makes them raise and lower the rate? What does it mean for your student loans in the long run? These and other questions are going to be addressed.
Here, we take a closer look at the way it all works and how it influences how much or less you’re going to pay for the things you need and want.
Understanding “The Fed”
The Fed refers to the Federal Reserve. Basically, it is the central banking institution for the United States. It’s overseen by Congress as a way to safeguard and stabilize the nation’s financial system. The Fed was created in 1913 as part of the Federal Reserve Act and is tasked with various specific responsibilities, including the supervision and regulation of the nation’s banks and financial institutions. The Fed also offers financial services support for the U.S. government and all financial entities in the U.S. as well as foreign official institutions.
The Fed protects the strength of the financial system. It assesses any risks that impact that stability in the foreign markets. It sets policy for the country’s monetary functions by way of influence on its money and credit positions for the purposes of regulating the economy.
That last purview is where the raising and lowering of rates come in due to the Fed’s efforts in keeping the economy robust and people employed. Thus, prices for everything are set at levels that continue to stimulate growth.
The individuals who are assigned the duty of making sure the Fed operates properly are the Board of Governors, seven people who are first nominated by the President and later confirmed by the Senate. They work with a full battery of analysts, economists, and aides to create regulations that are designed to maintain the health of the economy.
The Federal Open Market Committee is the entity that oversees interest rates. The decisions of this governing body are made in an effort to protect consumers during difficult economic times. For instance, the Fed will typically lower rates in a bid to stimulate growth — such as it did in 2008, when the country was gripped in a crippling recession and the economy was stagnant.
The Fed reduced the rate so dramatically that interest rates were lower than they had ever been before. That enabled Americans to borrow more readily and invest in stocks and start small businesses — all of the things that help to kick-start the economy were within reach since the rate was so low.
By December 2015, the Fed raised the rate because the economy was thriving once again. Plus, that growth remained on a steady track through 2016. That’s when the Fed decided to raise the rate once again.
Getting a struggling economy on track is important. However, it’s also just as critical to keep the economy from growing too fast, Thus, a raise in the rate is necessary to keep prices stable and the financial system working on an even keel.
To illustrate it more simply, higher rates keep price inflation down. Also, lower rates can mean more employment as companies and businesses hire additional people. Every time the Fed moves the rate, credit cards, savings accounts, and the interest you pay on mortgages and loans are changed.
That includes student loans. It can hit you where it counts, right in the wallet. On the flip-side, when the rates are raised, account-holders of various financial products are paid more in interest on their deposits.
The increase in 2016 was 0.25% — and while it’s possible there could be another hike or two coming in 2017, there is no guarantee that will come to pass. When they raised rates in 2015, the Fed claimed they would raise it four more times in 2016. However, that never really materialized. The first significant increase didn’t occur until this past December.
The Benefits of Student Loans
The student loan industry isn’t always spoken of highly. That is because there are so many people struggling with repaying their loans. The entire industry seems built upon the foundation of making people pay through the nose just to get a good education.
Yet, while it’s true that student loans have turned into a big business, they are also sometimes the only avenue for paying to go to school. Having one can also help you establish a credit score and get you started on building a positive credit report.
Paying your loan doesn’t have to be a nightmare either, as many of them come with concessions and benefits designed to make it easy to repay. However, when interest rates change, as they will when the Fed imposes a rate hike, the potential for financial trouble becomes more pressing to consumers.
Anyone seeking a student loan is typically going to try getting one through the government first. The money can originate with the Department of Education or from the educational institution where you plan to enroll. In this case, the money is lent through the Perkins loan program.
Although there are a number of loan arrangements available from the federal government, not everyone will qualify. For those individuals, a private lender is another choice. There is a myriad of lenders out there. Many of whom you’re likely familiar with, such as Wells Fargo and Sallie Mae. They all offer competitive rates for the purposes of attracting your business.
The Effect of the Fed Rate Hike on Student Loans
While a rate hike is going to have an effect on the country’s economic condition, it can be particularly impactful on student loans. To what extent, however, depends on the type of student loan you took, how much you have left to pay on it, and who issued it.
Private loans and federal loans could represent various changes to consumers. Additionally, if you’re refinancing a loan that might also come with some new wrinkles that needed to be ironed out.
Still, considering the size of the hike as just a quarter of a point makes the reality is that a majority of borrowers probably won’t see a major increase. Those who will feel the pinch are going to be consumers who have private student loans and anyone who has refinanced a loan with a variable rate. However, even that increase will be minimal.
If you are working with a federal student loan and you graduated a while back when rates were extremely low, then your rate is fixed. That means it can’t change during the life of the loan.
While that could be bad news when the Fed lowers rate, it’s great news when rates rise as they have now. Thus, if you got your loan around 2008 when the Fed dropped the rate down to near zero, you’re in great shape.
Nonetheless, if you got your loan prior to 2006, you will be affected even under a federal program. Back in 2006 and 2007, Stafford Loans came with variable interest rates.
These were based on certain factors such as the borrower being enrolled in classes, nestled within a grace period, or currently repaying the loan. Therefore, any loans made in 2006 or earlier came with variable rates and are subject to an increase.
Variable and Fixed
When you search for a student loan, regardless of whether you went with a private or federal lender, one of the major factors you faced was to decide to go with a variable or fixed rate. The two are pretty self-explanatory. The former can change and adjust for any number of reasons. The latter is locked-in so it won’t change.
This all results in how much you’re going to pay for the privilege of borrowing money from that lender. Variable rates could mean you pay more or possibly less than what you were paying at the start of the loan term. Fixed rates mean you pay the same amount every month until the loan is paid off. Additionally, it won’t change no matter what.
Obviously, this is where a Fed rate hike can affect your student loans (for those who have loans with variable rates). In most cases, variable rates are a component of private loans — though, as we’ve seen, there were some federal loans from over a decade ago that also came with variable rates.
When we talk about the “rate” rising or falling, we are referring to something called the Federal Funds Rate. This determines the rate that banks use when they charge each other for exchanging money. You wouldn’t be at fault for thinking this was the reason why your interest rates shifted on a variable rate loan.
It’s actually predicated upon something called the London Interbank Offered Rate (LIBOR). That is the real culprit responsible for determining how much more or less you’re going to pay on that loan monthly. However, the LIBOR rises and falls as the Federal Funds Rate moves back and forth. That’s why a rate hike can be highly influential in the condition of your loan payment.
Borrowing at Variable Rates
If you’re one of the millions who hold loans with a variable rate, you have a few choices. Since the hike is relatively small, the effect it will have on your rate is going to be mostly insignificant.
Nonetheless, for those folks struggling with their finances and every dollar counts when it comes to paying their bills and meeting their debt obligations. Therefore, an incremental change can prove to be difficult.
There’s also the possibility that the Fed will make good on its claim to raise rates again this year. Remember, they’re projecting it could rise four times in 2017. That could also bring additional financial hardship as your variable rate changes again and again.
In fact, the Fed has projected a slow but steady rise in the Federal Funds Rate all the way into the end of 2019. The higher the rate goes, so does your variable loan rate.
Consequently, you might consider getting out of the variable loan you’re paying off and switching to a fixed rate instead. This can be accomplished by refinancing or consolidation. A private loan can be refinanced with a private lending institution. They can offer you a fixed rate which may be lower than the current rate you’re paying now, even with the Fed rate hike.
In order to be approved, you will need to meet a few requirements. However, they aren’t anything new. You didn’t have to deal with the first time you applied for a loan. Your credit score is still going to be a major component of the approval process. Something in the high 600’s or above should do the trick. Additionally, you’ll need to demonstrate that you have a steady income.
For those of you with a federal loan, you can consolidate your pre-2006 variable rate loan by getting into a federal direct consolidation loan. That will automatically come with a fixed rate since the government phased out variable rates on its lending practices.
What it Means for Private Loans
Maybe you’re already paying off a loan or you’re currently shopping around for a student loan in anticipation of starting your college career. Accordingly, the rate hike is going to have some influence on what you pay.
Private student loans are often the second choice for many potential borrowers. These loans offer a range of borrower protections and considerations. They let customers defer paying off the loan while they are in school. Also, they provide financial hardship forbearance when the economy gets bad, a job has been lost, or some other financial difficulties have emerged to put the squeeze on a borrower.
If you are among those who are seeking out a loan now, you typically have the option of selecting a variable or fixed rate with a private lender. Each one comes with certain criteria that make them suitable for comparison and contrast.
This is because you could be ultimately become saddled with a higher payment over time with a fixed rate. A variable rate could prove to be a cheaper payment. You just run the risk of that payment increasing in the future.
Nevertheless, if you’re weighing that option now, you have some information upon which to base your decision. As we’ve discussed, the Fed raised rates in 2015 and again in 2016. Both were fractional, but they were still increases and if the projections hold the rates will continue rising.
Therefore, it stands to reason that when you select a rate on your loan, a fixed rate might be the better option in the current economic climate. Let’s say you’re considering taking a year off before attending college. In that case, you may also want to keep cognizant of the potential increase and weigh the pros and cons of securing that loan now instead of later.
Those who have loans already will see an increase in their payments. All the same, it won’t be a considerable rise in your costs. Anyone looking to refinance might want to pull that trigger soon as well. That is because the rate increase could mean a higher rate on your re-fi compared to what it has cost previously.
Additionally, you should seek out any other options that are offered to consumers to help bring interest rates down on a loan. Some lenders will drop a rate if you sign up for automatic bill pay. Also, if you meet some other standards criteria that will make you eligible for further discounts.
What it Means for Federal Loans
Federal loans are going to remain mostly unchanged, as we’ve determined. Any federal student loan given out between July 1, 2006, and July 1, 2016, come with fixed interest rates. They will remain the same until the end of the loan period. That is regardless of any additional hikes or drops that the Fed might impose.
Loans made prior to 2006 could have a variable rate. In this case, the section that pertains to you is located above. Not all federal loans issued prior to July 1, 2006, have a variable rate. Some were disbursed with fixed rates as they are now.
Since these loans were made over a decade ago, you may wish to revisit your loan agreement, just to remind yourself if you have a variable or fixed rate. It doesn’t hurt to check. That is due to the fact that it could mean you end up saving some money.
If your rate is indeed variable, then you may want to consider consolidation and get the fixed rate. You should get on it soon. This is because the rate you lock in now could end up being lower than the rate you may be able to lock down later on when rates are increased again. July 1st is the date when changes are implemented. Thus, you could see the rate shift once again in the summer of 2017.
The Decision to Refinance
Refinancing should be a decision made without too much procrastination. This is because the rates have already increased. Additionally, they could climb slightly higher over time. It’s better to get in on the ground floor before further hikes take place.
As the rate goes up, it will start to become less beneficial to refinance. That is due to the fact that the new rate you could be getting may not be all that much lower than the rate you’re getting now. It may not be worth it ultimately, not just for the time, money, and effort you’ll expend. Also, because you could lose some of the perks and advantages you are enjoying with your present loan arrangement.
This is particularly true with federal loans which offer liberal repayment scenarios that include free help with your student loans. Additionally, forgiveness programs may be advantageous to your financial situation. You may run the risk of forfeiting some of these benefits if you refinance. Therefore, be sure that refinancing is going to save you enough money to make it worth your while and possible sacrifice.
Our Final Thoughts
As of 2016, there is $1.27 trillion of student loan debt in the United States. Only seven percent accounts for private lenders. The remaining 93 percent can be found in federal student loans. Under those numbers, a substantial portion of borrowers won’t be forced to contend with rate hikes from the Fed as they pay off student loans.
That smaller portion will be affected but not by a whole lot, at least for the time being. Although the Fed has announced there could be further rate hikes in the future, that doesn’t mean they will actually be implemented. Even if they are, these could also be as incremental as the most recent quarter percentage point from 2016.
What does it all really mean for student loans? It means you may need to consider getting a fixed rate on your loan or adjust your monthly budget. That will account for the minor increase in your student loan payments.
You may need to scale back on another line item of your monthly household budget, one that isn’t as mandatory or could be eliminated altogether. Only you know what your present financial situation looks like. Hence, re-examine your spending and find a way to make up for this additional expense you will need to incur in the foreseeable future.
