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Rising federal interest rates pinch student lenders

Your student loans just got more expensive. 

The Federal Reserve is steadily increasing the federal funds rate to mitigate inflation. For college students, that translates to more expensive federal and private loans. 

At Notre Dame, 24% of first years took out federal loans in 2020, and 11% took out other or private loans. This July, interest rates to borrow money from the U.S. government to pay for higher education ballooned to nearly double the 2020-2021 interest rates. Private rates, which are often variable and more expensive, will follow suit. 

For the 2022-2023 school year, federal loans carry a 4.99% interest rate, compared to rates of only 3.73% from 2021-2022 and 2.75% from 2020-2021. Graduate students will pay 6.54% this year. 

Student loan rates are spiking as the Federal Reserve continues to raise interest rates.

On top of low interest rates, the U.S. Department of Education paused all repayments and set interest rates to 0% in March 2020. Interest accrual and repayment are slated to resume this January. 

Once the zero percent interest rate break evaporates, students with unsubsidized student loans will rack up almost 5% interest for money loaned this year.

This shift arrives as the Federal Reserve continues to stymie inflation by raising interest rates from the record lows of the COVID pandemic. 

Kristen Collett-Schmitt, a Notre Dame finance professor and associate dean for innovation and inclusion, said interest rate increases are putting more financial strain on student borrowers. 

“Students looking to borrow now are going to be paying more in interest than students two years ago,” she said. “From an equity perspective, that’s difficult because we’ve seen the cost of higher education steeply increase in the last several years. That increases the need for borrowing, and now the cost of borrowing is going up.” 

Federal direct subsidized and unsubsidized loans are issued each school year, so it’s possible for a borrower to have four loans with four different interest rates by graduation. Based on the class of 2022, total federal student loans average $21,362 at the time of graduation. Notre Dame graduates have a loan default rate of less than 1% for the past two decades. 

While no student is required to make minimum interest payments while enrolled full time, those with unsubsidized loans accrue interest that is capitalized, or added to the principal amount loaned, upon graduation. The Notre Dame office of financial aid recommends students with unsubsidized loans pay the interest that accrues while they are in school if possible. 

Students with unsubsidized federal loans might not see this year’s 4.99% interest rate right now, but it’s working behind the scenes. 

For a first-year student taking out the maximum $5,500 in unsubsidized loan funds, interest will amount to $1,098 by the time of graduation. That’s after accumulating daily at this year’s 4.99% fixed rate for four years. A first-year student in 2020 borrowing the $5,500 maximum amount will accrue only 41 cents of interest each day. Loans from the 2022-2023 school year will accrue 75 cents per day. 

For personal finance purposes, Collet-Schmitt says students should understand the lending terms, think about their future plans, consider when repayment will be possible, investigate whether a fixed or variable interest rate would be in their best personal interest and plan for repayment flexibility. 

While the economy has been unpredictable for the past few years through the COVID pandemic, Collett-Schmitt says interest rates have followed it as economists would expect. 

“What we’ve seen with interest rates over the last two years is 100% attributable to the economic turmoil that we’ve experienced. It was textbook in the sense that when we saw the economy suffer as a result of the pandemic, the Federal Reserve lowered its target to stimulate spending rather than saving,” she said. “Now we’re seeing inflation take its toll on the economy. [The Federal Reserve] wants to tamper demand and spending to help with inflation. A higher interest rate is going to do that by discouraging the borrowing that often leads to spending. Although the economy is not always predictable, how the Federal Reserve responded to the economic condition with the federal funds rate certainly was.” 

In terms of borrower behavior, Collett-Schmitt said higher federal student loan rates might push some students to reconsider attending college. Others might seek work-study programs or scholarships more fervently than before. 

Students who have borrowed federal money can check the status and interest rates of their loans on the federal student aid website.

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