What Is a Student Loan Interest Rate And How Does It Work?
The correlation between education and earnings shows that higher learning is still one of the best investments in your future well-being. However, it's still not a thing every student can afford without additional help. And that's the reason why most people turn to student loans. But here is a question that usually arises – "How much interest rate for student loan options do I have to pay?". And there is no simple answer to this matter, as there are various factors that impact it.
The current student loan interest rate depends on the type of financial aid you mean – federal or private. Also, your educational degree, financial situation, and credit history can influence the figure of student loan rate you will be offered. While federal student loan rates are always fixed, private aid can come with both fixed and variable rates, so your total loan cost and monthly payments can fluctuate following economic market trends. So let's take a closer look at all the available options in the 2022-23 school year and find out how typical student loan interest rates work.
Table of Contents
- What Are Available Types of Student Loans?
- What Are Current Student Loan Interest Rates – Federal Student Loans
- How Do Private Student Loan Interest Rates Differ from Federal Ones?
- What Is an Average Student Loan Interest Rate in 2022-23?
- How to Calculate a Student Loan Interest Rate?
- How Are Interest Rates on Student Loans Set?
- How to Get a Lower Interest Rate on Private Student Loans?
- What Should We Expect from Student Loan Interest Rates in 2022-23?
What Are Available Types of Student Loans?
Student aid in the US can be divided into federal and private. Federal student loans are a type of aid issued by the federal government, while private loans refer to a form of debt you can obtain from private lenders, such as banks, credit unions, state agencies, or even schools. But this is not the only distinction between them. In fact, the most significant difference lies in their costs, payment schedules, and the requirements for getting them. But first things first.
Federal student aid consists of three general options:
- Direct subsidized loans. The government provides subsidized loans for those undergraduate students who can't cover tuition expenses and the cost of education on their own due to the difficult financial situation they experience. This way, you need to prove you or your family have a cause in the form of insufficient income. The government normally covers your loan interest for you while you're studying;
- Direct unsubsidized loans. Unsubsidized loans can be obtained by both undergraduate and graduate students who don't experience financial need. In comparison with direct subsidized loans, this type of student aid usually has higher interest rates;
- Direct PLUS loans – PLUS loans are a good way to use when you need to pay for any remaining tuition costs that are not covered by other types of aid. They are available for graduate and professional students, as well as for parents of dependent undergraduate students. Also, unlike the options above, this type of federal aid comes with a hard credit check and pays attention to a borrower's credit score.
One of the best things about federal student loans is that you don't need to make your loan payments while you're still in school. Your payments become due only after you leave school or change your enrollment status. Also, federal loans (except for a PLUS loan) don't base their aid on borrowers' credit scores. However, each form of federal student aid obliges you to show satisfactory academic progress that meets your student's school requirements.
Private loans are issued by private organizations and financial institutions. They work similarly to personal loans and always consider a borrower's credit score. Also, most private loans require a co-signer if you have no credit and/or stable source of income. Most private student loans require you to make your monthly payments right after you receive the aid. There is no grace period while you're in school. They are also not a subject of the Public Service Loan Forgiveness program.
Summing up, federal loans have more favorable conditions compared to private ones. Therefore, more than 90% of student debt in America refers to federal student aid. However, such loans have some annual limits that are not always enough to cover all the educational expenses you have. Therefore, students often turn to private loans after they exhaust their federal student loan options.
What Are Current Student Loan Interest Rates – Federal Student Loans
Federal loans provide fixed interest rates that are between 4.99% and 7.54%. A 4.99% interest rate is available to undergraduate students who apply during the 2022-23 school year. Graduate or professional students can access an interest rate of 6.54% for direct unsubsidized loans and 7.54% for direct PLUS loans. A fixed borrowing rate means that you have the same interest rate until your loan expires. Therefore, your monthly payment amount will always be predictable.
Note: Don't forget about federal loan fees that also affect your total loan cost. At the moment, undergraduate loans (both subsidized and unsubsidized) come with an origination fee of 1.057%. Loan fees for graduate student options are 1.057% or 4.228% for unsubsidized loans or PLUS loans, respectively.
How Do Private Student Loan Interest Rates Differ from Federal Ones?
When it comes to a private student loan, your interest rate may vary significantly depending on your (or your co-signer's) credit score, income, and debt-to-income ratio. This way, students or their parents with good and excellent credit scores can get quite competitive rates, while those with credit issues shouldn't expect a private lender to offer them a value that is close to federal student loan interest rates.
Another metric that affects private student loan rates is who applies for it. Moreover, the type of interest rate you choose also plays a role. While a fixed interest rate is more predictable, loans with variable interest rates are commonly cheaper. Here are examples of an annual interest rate you can get depending on the mentioned factors.
Loans for Undergraduate Students
- Fixed: between 3.5% and 16.06%;
- Variable: between 1.13% and 14.86%.
Loans for Graduate Students
- Fixed: between 3.5% and 16.75%;
- Variable: between 1.13%and 14.40%.
- Fixed: between 3.99% and 14.96%;
- Variable: between 1.97% and 14.91%.
Note: There are many criteria that determine your loan's interest rate. It also depends on the particular lender you work with, so the values above are for informational purposes only. Also, each lender may set an origination fee that will affect your private loan cost.
What Is an Average Student Loan Interest Rate in 2022-23?
The average student loan interest rate for both private and federal student loans is 5.8%. However, keep in mind that more than 90% of all student debt comes from federal student loans. If we take a look at private student loan statistics, this figure will be higher. For a fixed rate, it can range from 4.2% to 9.8%, while variable loans come with an average of 1.9% to 10.9%.
How to Calculate a Student Loan Interest Rate?
Student loan interest rates are calculated as follows:
- Calculate your interest rate factor. To make this, divide your annual rate by the number of days in the year (365).
- Find the daily interest accrual fee. Multiply your outstanding principal balance by the daily rate you calculated.
- Determine the amount of your monthly payment. Multiply the figure you got in the second step by the number of days between the last and current payment date (it's also called a billing cycle).
Representative example: If you owe $20,000 with a 4.99% interest and a 30-day billing cycle, here are your calculating steps:
- 0.0499 / 365 = 0.00013671 – here's your interest rate factor.
- $20.000 x 0.00013671 = $2.734.
- $2.734 x 30 = $82.02.
This way, you get the amount of interest you have to pay when you make your first monthly payment. As each of your monthly payments reduces the principal balance, less of your monthly payment will go toward interest with the lapse of time.
You can also use a student loan calculator that will make all computations relying on your annual interest rate, loan amount, and loan term.
How Are Interest Rates on Student Loans Set?
Both federal and private student loan interest rates follow larger economic market trends, so their fluctuations are closely related. If federal student loan interest rates grow, private ones are likely to follow, and vice versa.
Federal Student Loans
Federal student loan interest rates are set by Congress each spring. The rates they set are in effect for all student loans disbursed between July 1 and June 30 of the following year. As a federal loan is a fixed-rate loan, interest rates on it remain the same within the whole loan term for all existing debts.
Private Student Loans
The Secured Overnight Financing Rate (SOFR) or Libor indices are the most common metrics that affect private loan interest rates. But in addition to these factors, private lenders tend to consider your income, credit score, and financial history when setting a loan rate. Therefore, if you or your co-signer can show that you have a solid financial status and a high credit score, private lenders may be willing to give you a better rate.
How to Get a Lower Interest Rate on Private Student Loans?
If you want to get the best possible private student loan rates, here are some useful tips to consider:
- Improve your credit rating. Of course, it typically takes more than a few days, but you can still take some steps to increase the chance of getting a lower rate. Check your credit report for mistakes and try to pay off your existing debt if you have any;
- Refinance your student loan. Options for student loan refinancing are used to cover existing student loans and get better loan conditions due to a lower rate. Only private lenders provide this option. But keep in mind that perks like income-driven repayment plans or coronavirus forbearance will no longer be available if federal loans are refinanced;
- Find a co-signer. Your loan can now have a co-signer if your credit score and financial situation are not disposed to getting favorable conditions. Your co-signer needs to be a reliable borrower with a high enough income to raise your creditworthiness in the eyes of lenders.
What Should We Expect from Student Loan Interest Rates in 2022-23?
Unfortunately, the student loan interest rate tends to grow year after year. Although the US Department of Education decided to extend COVID-19 emergency relief for eligible student loans this August through December 31, 2022, the chance that the interest rate will drop is negligible.
Due to record-breaking inflation and global economic fluctuations, interest rates on both federal and private student loans have grown over the past year. By increasing its federal funds rate six times so far this year, the Federal Reserve has had an impact on the increases in interest rates for student loans. As a result, interest rates have consistently risen for the majority of lending options. For example, until July 1, 2022, the interest rate on subsidized loans was 3.73%, on unsubsidized loans - 5.28%, and on PLUS loans - 6.28%. Thus, we suppose that the interest rate will continue to grow since there are no economic prerequisites for its reduction so far.
What Is The Average Interest Rate for a Student Loan?
Among all the borrowers and types of student aid, the average interest rate for a student loan is 5.8%.
Should I Choose Fixed Interest Rates or Variable Interest Rates for Private Student Loans?
While a student loan interest rate tends to grow, it may be better for you to choose fixed rates to save money over the years. However, variable rates are initially lower than fixed ones, so if you're going to pay off your student loan debt early, a variable rate loan can work better for you. If you have a good credit score, variable rate loans may offer you fringe benefits in terms of interest rates.
Do Student Loans Pay Off?
There is a strong link between education and income, so your education should be considered one of the best ways to reach your financial goals. However, consider all your options and choose the one with the most favorable terms.