When you get a loan, you repay more than the amount you borrow. It is the interest that causes this difference. Interest rate is the percentage of the unpaid debt balance. The rate depends on many factors, including the type of loan, timing, borrower qualifications, etc. However, checking the average student loan interest rate can help borrowers to make better decisions for their finances. It is essential to compare the interest levels of various loans and choose the most suitable one. This guide presents you with different rates observed since 2006 and ways to reduce your interest payments. Lastly, we answer the three most important questions on interest.
Changes to Federal Student Loan Rates
Federal student loan rates change every year. The change subsequently impacts the average student loan interest rate, too. In July end, the Education Department announced new rates for the 2021-2022 academic year. Although borrowers hoped for lower rates, the federal student loan interests increased compared to the previous year. There is around a 0.98% increase in rates for undergraduate, graduate, and PLUS loans.
Undergraduate loans can be subsidized or unsubsidized. The first one is for borrowers who are in financial need. These borrowers should prove financial need with documentation. Meanwhile, unsubsidized loans do not require demonstrating financial need. Therefore, sometimes, subsidized loans are cheaper for debtors.
This year, undergraduate interest, both for subsidized and unsubsidized loans, increased to 3.73% from 2.75% (which is last year’s interest rate). Although there is an increase in student loan interest rates, unsubsidized loans are still more affordable than other loan types.
Loans for Graduate Students
Graduate students can only get unsubsidized loans. They do not qualify for subsidized debt, which means they do not need to prove financial need. Generally, the average student loan interest rate is higher for graduate students. Hence, it is not surprising that the federal student loan interest rate for such students is now 5.28% – higher than loans for undergraduate students. For further information, last year, this rate was 4.30%.
Compared to the loan as mentioned above, the average student loan interest rate for PLUS loans has always been higher. These loans aim to help borrowers- graduate/professional students and parents of undergraduate students. It has two different subcategories. For professional and graduate students, the funding type is called Graduate loans.
Meanwhile, for parents of undergraduate students, it is called Parent PLUS loans. Regardless of the type, the current interest rate for these loans is set to 6.28%. This rate is higher than subsidized and unsubsidized loans. Last year, the rate was 5.30%.
Why Federal Interest Rates Increase?
It is disappointing to see how interest rates for federal loans are increasing. After all, these loans are usually the most affordable financing type for education if you lack money. However, there exists a reason behind the changes. It is not Congress that is deciding what the rate should be. Instead, these rates are tied to an external factor, such as a 10-year Treasury notes auction. As the external factor changes, federal student loan interest rates also vary. This is why the average student loan interest rate for federal debt increased.
Do Changing Rates Affect My Debt?
If you have already taken federal loans, the changing rates do not affect you. For example, if you took loans before July 2021, new rates do not increase your interest payments. However, generally, federal student loans are the cheapest option. Hence, when their interests rise, it is possible that private student loans will also increase. However, it should be added that private lenders determine their interest rates independently. So, no change in private debt can also be observed.
Does New Rate Apply to Paused Federal Loans?
Currently, federal loans are in a non-repayment period. Such a benefit is due to the negative consequences of the pandemic on borrowers’ finances. Therefore, the government granted the non-repayment privilege to federal loan borrowers till February end, 2022.
During this period, any change in new interest rates does not apply to existing loans. So, your interest rate will not change when you resume repayment in 2022. You will continue repaying debt with an interest rate determined in your loan agreement.
Average Student Loan Interest Rate
Now that you know the current rates for federal student loans, it is time to discuss the average student loan interest rate. The average federal debt interest rate was 4.66% for undergraduate students, considering rates after 2006. It means, currently, the rate -3.73%- is under this average. The average is 6.22%, which is higher than the current 5.28% when it comes to graduate borrowers.
Lastly, for PLUS loans, the average is determined as 7.27%. It is also higher than the current rate – 6.28%. To sum up, undergraduate loans are now cheaper than the average, while graduate and PLUS loans are more expensive in 2021.
Private Student Loan Rates
While the rates for federal loans do not have a wide range, private student loan rates vary a lot. Each lender can decide what the interest level will be, which leads to many different rates. The statistics indicate that the average student loan interest rate for private debt is 6.17% for the five-year, variable-rate debt. For fixed and 10-year debt, the interest increases to 7.64%.
Generally, it is possible to find private student loans with interest as low as 1.25% (variable) and as high as 12.59%.
What Affects the Federal Loan Rate?
We previously discussed that the interest level for federal student debt depends on 10-year Treasury notes. However, there also exist other factors that determine what your interest rate will be. For example, the type of loan matters. If you get undergraduate loans, your interest can be lower. Besides, subsidized loans are usually cheaper than unsubsidized debt.
Additionally, undergraduate students enjoy lower interest levels than graduate students even if they get the same loan -such as an unsubsidized loan. Hence, borrowers’ types are also important. Lastly, the timing of the loan has an impact on this decision. Each year, the rate changes. You can enjoy the current rates only till July 2022. If you receive loans after this period, you might get even more expensive loans, or maybe, on the contrary, cheaper debt.
What Affects the Private Loan Rate?
The average student loan interest rate changes for private debt. The interest level usually ranges from 4% to 12.6%. Therefore, it can be hard to determine what your interest will be. There exist several factors that affect the final interest level for your private student loans.
For instance, your lender has a great impact on the rate. Each lender has its terms and regulations. So, they can decide what to offer. Sometimes, they can provide lower interest to compete with other private lenders.
Next, the credit score is essential. A credit score indicates your credibility. Borrowers with a high credit score- 600 or more- can qualify for lower interest. On the other hand, debtors with low scores will be eligible for higher interest rates. The reason behind this difference is that borrowers with bad credit performance are risky. They might not even repay the debt. To hedge against this risk, the lenders offer high rates.
Lastly, private loans are dependent on the economy and what is going on in the market. Hence, when the average student loan interest rate rises for federal debt, the private lenders also change their strategies.
Fixed-Rate Loans vs. Variable Rate Loans
Federal student loans have fixed rates. It means you pay the same interest level during the whole repayment period. However, when you have variable rate interest, it can change – increase or decrease- during the repayment.
How Can I Lower Interest on My Loans?
If you are not content with your current interest payments, you can find ways to decrease them. One of the main options for lowering interest payments is student loan refinancing. Refinancing loans help borrowers to use the money for paying off the existing expensive loans. For example, imagine you have a loan with a 7% interest rate. If you can find a refinancing loan with 5% interest, you can use the money to get rid of 7% interest. As a result, you save money in the long run.
What is the Logic behind Refinancing Loans?
You might wonder why refinancing a student loan is a good idea. Sometimes, borrowers get private loans as soon as they graduate. At this time, the borrower does not have a good credit history. Hence, the lenders offer high-interest loans. However, as time passes, the borrower gets a job and improves credit performance. Therefore, when he or she applies for refinancing loans, they qualify for lower interest rates.
Another case can happen due to economic changes. It might be possible that the market interest rates start declining after you get your loan. If you have a fixed interest rate, the declining average student loan interest rate will not have any impact on your debt. In this case, you can refinance so that you get a new cheaper loan.
Eligibility Requirements for Refinancing a Loan
Compared to getting federal student loan debt, refinancing loans has more eligibility conditions. The most important two factors are to have a stable income and a good credit score. If you want to get any private loan, you will come across a lot of credit score requirements. Your credit score indicates how credible or reliable you are as a borrower. Lenders usually prefer distributing cheap loans to the most credible borrowers. Hence, refinancing loan servicing companies typically require 600 or more credit scores from the applicants.
Another condition has a stable income source. In this way, the lenders ensure repayment.
The Benefits of Cosigner
We have already discussed the requirements for refinancing a student loan. You might wonder what happens if you do not have the necessary conditions. The answer has a credible cosigner. A cosigner is a third-party ensuring the repayment. If the borrower fails to repay the debt, the cosigner should pay. Otherwise, the credit score of both will fall. This person can be a family member or friend. However, keep in mind that the requirements also apply to the cosigners. They should have well-paid jobs and excellent credit performance.
Even if you qualify for a refinancing loan, it is a good idea to involve a cosigner. Usually, a loan with a cosigner has a lower average student loan interest rate.
There is also a feature called “cosigner release.” This feature allows borrowers to free the cosigner after making several payments. When the borrower makes a certain number of payments, they gain the trust of the lenders. Hence, the lender allows the cosigner to walk away.
3 FAQ on Interest
Throughout the guide, we present the average student loan interest rate and the current rate for different loan types. However, it is advisable to understand how interest works before checking the numbers. Otherwise, you can make uninformed decisions.
1. What is Interest?
A loan is a type of financing that requires repayment. Repayment makes it different from other financial aid types such as grants, scholarships, etc. However, when you repay the debt, you do not pay the amount you borrowed. Instead, you pay the original debt balance plus interest. Interest is some percentage of the unpaid debt balance.
These loans are also called installment loans. It means borrowers take money, then repay the original balance with interest. Once repayment is complete, the account is closed. In contrast, there also exist revolving debts, such as credit card debt. In such types of financing, the account is not closed, and you can use this financing method again anytime you want.
Some debt types have higher interest rates, while others have lower interest. For example, credit card debt is one of the most expensive ones. On the other hand, compared to private student loans, federal student loans are cheaper. Hence, when you need additional funding for your education, you need to compare different options and choose the most suitable one.
2. What is Capitalization?
You need to be extra careful about the capitalization of accrued interests. Capitalization is the process of adding interest payments you did not make into the principal debt balance. This process is not desirable as interest is determined as a percentage of the unpaid debt balance. If the principal balance increases, your future interest payments also increase.
Yet, capitalization happens under various conditions. For example, if you have unsubsidized loans and get loan deferment, your interest payments will accrue during the non-repayment period. Besides, if you forget recertifying your income for some Income-driven repayment plans, capitalization can happen.
Currently, the government applies non-repayment benefits to federal student loans. Hence, borrowers are not required to make any payment for federal loans till February 2022. The best side of this benefit is that the interest rate is set to 0%. Therefore, no interest payment is considered unpaid. Subsequently, you do not need to worry about accruals or capitalization.
3. How Is Interest Calculated?
Let’s focus on Direct loans to understand interest rates better. First, keep in mind that Direct loans are accrued daily.
If you miss the payment deadline, the interest will start accruing. Depending on your debt type, the accumulated interest can be capitalized, which we will discuss later.
You can calculate the accrued amount with the following formula:
Interest = (Interest Rate Factor x Unpaid Debt Balance) x Number of Days Since Your Last Payment In addition, the average student loan interest rate factor can be determined by dividing interest by the number of days in a year.