In an emergency move, the Federal Reserve cut the federal fund rate to 0% to offer relief to Americans affected by the coronavirus pandemic. This move was meant to help ease the flow of credit for businesses and borrowers during tough economic times.
During the onset of recessions, this is a common move by the Federal Reserve. It is even more likely that the Federal Reserve will keep the federal fund rate at or close to 0% for at least a few months due to the nature of this economic and health crisis.
If you have student loans a lower federal funds rate could help save you money, here’s how.
What is the federal funds rate?
The federal funds rate is the rate banks charge each other when they exchange money.
This is not the only rate that is used to set the rates we pay on debt though. LIBOR, or the London Interbank Offered Rate, is typically used by private lenders, including for variable rate private student loans. LIBOR is the rate that global banks charge each other for short-term loans.
The federal funds rate and LIBOR are typically in sync with each other. As one falls, the other typically does as well. These two are the most widely used rates in the world, and both are at or close to 0% at the moment.
Unfortunately, this does not mean all new student loans are offering 0% interest. For a short time frame, all federally owned student loans are not charging interest but this is temporary relief due to the coronavirus pandemic. The administration’s pausing of interest on student loans was likely to encourage borrowers to keep their federal student loans as federal loans, and not refinance them into private student loans during this low-interest rate period.
Lower Rates for Variable Rate Student Loan
A variable rate loan changes its interest rate as benchmark rates do, unlike a fixed-rate loan. Federal student loans and private student loans can have a variable rate. Variable rates were no longer available on federal student loans that were taken out after 2006.
Unlike a fixed-rate loan, a variable rate loan changes as the LIBOR or federal fund rate does. Normally, this rate is the benchmark rate plus an additional few percentage points. Some lenders set a cap on how low their variable rates will go, so be sure to check the fine print on the terms of your loan.
If you have a variable rate loan, your rate will adjust automatically up or down over time. You should see the effects of the fed cutting rates soon if you have not already.
Because rates are so low right now, it could be time to refinance your variable rate private student loans into a fixed-rate loan to lock in your rate for years to come. If your student loans remain a variable rate loan, you will see an increase in your rate if the Federal Reserve starts increasing the federal funds rate overtime.
You can also consolidate your variable-rate federal student loans into a federal direct consolidation loan to lock in a fixed rate. If you are already pursuing Public Service Loan Forgiveness, do not consolidate your federal student loans as this will reset your qualified payment count.
If you are on an income-driven repayment plan you will not see a change in your monthly payment due to this rate cut, even if you have a variable rate loan. You will, however, see a change in how your payment is applied and could see more of your payment go to your principal balance.
No Changes to Fixed Rate Federal Student Loans
If you have federal student loans with a fixed interest rate, the fed cutting rates will not affect your student loans automatically. To see any benefits from this low-interest-rate environment, you will need to refinance your federal student loans into private student loans.
Be sure to review the pros and cons of refinancing your federal student loans before signing on the dotted line.
Should you consider refinancing your Federal Student Loans to Private Student Loans?
If you have any desire to pursue Public Service Loan Forgiveness, do not refinance your student loans. Refinancing your federal student loans into private student loans to save a few percentage points in interest could end up costing your thousands, if not tens of thousands, of dollars in opportunity costs by not having your loans forgiven.
Once federal student loans become private student loans, you lose all options for forgiveness and income-driven repayment plans. Here is an example of the hidden opportunity cost of refinancing your federal student loans into private student loans if you are pursuing, or thinking about pursuing Public Service Loan Forgiveness.
|Current Federal Student Loans||New Private Student Loan|
|Loan Balance Now||$200,000||$200,000|
|Monthly Payment||$390 to $1600||$2,121|
|Months to Payoff||120||120|
|Total Out of Pocket||$125,500||$254,500|
Assumptions: A single resident with 4 years of residency left making $65,000 per year, and will make roughly $180,000 per year after that, an annual 3% raise, repayment plan used was PAYE assuming no interest subsidies, they have not earned any qualifying payment counts towards Public Service Loan Forgiveness yet, and we assume that their loans qualify for Public Service Loan Forgiveness. These figures are for illustrative purposes only and are rough estimates.
For this borrower, refinancing their federal student loans and losing their eligibility for Public Service Loan Forgiveness cost them roughly $129,000 if they would have pursued this forgiveness program.
If you are not pursuing a forgiveness program and are considering refinancing your federal student loans into private student loans, here is what to consider before you do:
1) Are all of your loans high interest?
It could be that you only need to refinance a portion of your total loan balance or one of many of your loans that are high interest.
If you are not sure what interest rate your loans are at now, log into the Federal Student Aid website and review your National Student Loan Data File.
2) Do you need the benefits of federal student loans?
Considering going back to school? Federal student loans could be placed in an in-school deferment period, this is not a given with private student loans.
Do you want the option to place your loans in forbearance? That is not as easy with private student loans as it is with federal student loans.
For the next 60-days, federal student loans can be placed in a temporary forbearance as part of the coronavirus relief package from the Department of Education. If you need a break on your student loan payments, now might not be the time to refinance.
After refinancing your federal student loans you also lose access to all forgiveness programs such as Public Service Loan Forgiveness, Time-Based Forgiveness on an income-driven repayment plan, and other local or state-specific forgiveness programs.
It may not be best to refinance your loans to save money on interest charges if you need access to any of these benefits of federal student loans.
3) Are you eligible?
As a resident or fellow, your income to loan ratio is typically fairly high. Many lenders may require a co-signer because of this. If you are unable to or not comfortable adding a co-signer, refinancing might not be an option for you.
Private student loans qualifying requirements may mean you are not eligible to refinance your student loans at this time.
4) Can you afford the new monthly payment?
If you refinance your loans, chances are your payment will increase. This is especially true if you are currently on an income-driven repayment plan. Before you refinance, check your budget to see if the new payment is feasible for you.
5) Are you actually saving money?
Refinancing your student loan to a lower rate could actually end up raising your total out of pocket cost. If your term is extended and you are offered a lower monthly payment, be sure to use this quick check to make sure you are actually saving money.
Total Out of Pocket Cost = Monthly Payment x Number of Months
Here is an example of how a lower rate could actually increase your total out of pocket cost.
|Payment||$955 / Month||$506 / Month||$995 / Month|
|Total Out of Pocket Cost||$57,300||$60,750||$54,815|
Lowering this borrower’s rate by 1.5% but increasing their term, costs this borrower just over $3,450. However, if they continue making the same monthly payment of $955 a month instead of the required minimum payment of $506 a month on the new loan, they could save $2,485 and reduce their payoff timeline by 5 months.
If you decide to refinance your federal student loans into a private loan, do so with caution. Be sure to consider the benefits of federal student loans, your budget, and the total out of pocket cost before signing on the dotted line.
Should you consider refinancing your Private Student Loans into a New Loan
With rates at historic lows, you should see lower rates on new loans.
You could even see lower rates with the lender you are already with. If you see that your student loan lender is advertising lower rates on their website, give them a call! Ask them if you could refinance your private student loans with them at a lower rate for the same term. If they decline your offer, kindly let them know you will continue to shop their rates and may be refinancing your loan to another lender – this may help change their mind.
Changes to new student loans for the 2020 / 2021 semester
Federal student loan rates are decided by lawmakers between June and July each year for the upcoming school year. It is likely that rates for the Fall 2020 / Spring 2021 semesters will be set during this low-interest rate period; causing federal student loan rates to hit record lows.
New federal student loan rates are set based on the 10-year U.S. Treasury yield, not the federal funds rate. However, the 10-year U.S. Treasury yield tends to follow the movements of the federal funds rate closely.
Federal student loans for the current 2019 / 2020 school year will likely not see any impact from the federal funds rate being lowered as these were set in July 2019.
How does the Federal Reserve’s cutting of the federal funds rate affect your student loans?
Rates for new private student loans are at historic lows, and new federal student loans for the 2020 / 2021 school year probably will be as well.
If you have considered refinancing your student loans, now might be the time to refinance as rates are at historic lows. Before refinancing your federal student loans into private student loans, review these five points:
- Are all of your loans high interest?
- Do you need the benefits of federal student loans?
- Are you eligible?
- Can you afford the new monthly payment?
- Are you actually saving money?
If you have a variable rate student loan, it is likely your rate has already been adjusted or will soon. Be sure to check the terms of your loan to see if your loan servicer has set limits on how low your variable interest rate will go. Consider refinancing your variable rate loan into a fixed-rate loan to lock in a lower rate.
If you have private student loans now, try calling your loan servicer to see if you can get a lower rate with them. If not, shop their rates and decide if refinancing could save you money. Follow the same analysis under the “are you actually saving money” section under refinancing federal student loans to ensure you are not increasing your total out of pocket cost.
If you are planning on taking out new loans for the 2020 / 2021 school year, you likely will be able to lock in a low rate, saving thousands of dollars throughout the life of your loan.
Think carefully before refinancing your loans, but if refinancing makes sense for you – now could be a good time to refinance due to our historically low-interest rates.