Interest Rates and Your Loans for Education

Why Rates Matter

The interest rates attached to your student loans have an important influence on repayment terms and the length of time it takes to satisfy your student debt. Interest rates for college students are not standardized across the board, so government-backed loans generally carry the best repayment schedules for borrowers.  The U.S. Department of Education is in the business of promoting access to higher education, so interest rates on the loans they sponsor are among the lowest found on any financial instruments.

Typically, government-subsidized loans are offered with interest rates below 4%, and unsubsidized version still carry user-friendly rates below 7%.  Private student loans are issued by for-profit banks and credit unions, so interest rates are higher.  Compared to interest rates on business loans and credit cards, college students enjoy relatively low-cost access to loans for school.

Consider how interest rates factor-in to this hypothetical example of a typical student borrowing scenario:

You are a college student approved for a Federal Direct Subsidized Loan, in the amount of $5,000. The interest rate on this loan is fixed at 6.8% (between 2007 and 2012 this interest rate was adjusted incrementally, to its current position at 3.4%). Under these circumstances, at 6.8%, approximately $340 interest is added to your loan each year, once repayment begins.

If your loan is Unsubsidized and you defer loan interest payments for four years – until after you’ve graduated, your new loan balance will stand at $6,360.

Student loan interest rates vary by year and are governed by individual program rules.  The Higher Education Access Act of 2007 contains provisions that gradually lower federally sponsored student loan interest rates.

Student Loans with Interest

Student loans come with low interest rates, and they are usually fixed-rate products as well.  For students in repayment; low, fixed-interest loans provide consistent and manageable payment schedules.  These rates reflect recent prevailing student loan conditions:

• Stafford Loans borrowed since July 1, 2006 feature 6.8% fixed interest rates. The Higher Education Access Act of 2007 changed the rates.  Today’s Federal Direct Subsidized Loan interest rates are fixed at 3.4%
• Unsubsidized Federal Direct Student Loans are repaid at a fixed rate of 6.8% interest.
• Perkins Loans interest rates are fixed at 5%.
• Parent and Grad PLUS Loans interest rates are fixed at 8.5% for those borrowed since July 1, 2006 in the Federal Family Education Loan Program (FFELP), and at 7.9% for the same loans borrowed in the Federal Direct Loan program.
• Private or alternative student loans feature variable interest rates that may start off low and increase over time, similar to credit card rates. Read the fine print: “rates may change without notice.”

Just as important as the rate itself, is when an interest rate ‘kicks-in’ over the life of a loan.  Deferment, grace periods, forbearance and other repayment deflectors sometimes place interest accrual on hold, until the borrower is prepared to cover payments.  For some loans, like Parents PLUS, repayment begins immediately after funds are issued.  In other cases, interest payments are suspended until certain conditions are met.  Interest payments that are not subsidized by the U.S. Government are generally capitalized – added to the outstanding principle balance of the loan.

Tax Benefits

The Federal Government includes a money saving student loan interest tax deduction, for eligible federal income tax filers. To utilize the deduction, the loan must be a qualified student loan - intended only for college costs; and the filer must be the individual responsible for repaying the loan. For tax purposes, a student is defined as an individual enrolled at a post-secondary educational institution, in a degree or certificate program. Figure your interest rate tax deductions using the IRS Student Loan Interest Deduction worksheet.

Know Your Bottom Line Interest Rates and Fees

So how do you calculate the total interest obligation on your student loans? Most educational lending services and private banks feature student loan interest rates and loan calculators on their websites.  Plug-in your loan terms and other requested information to access a profile of your individual debt.

Here are a few critical interest rate questions that should be considered before entering into any student loan commitment:

• Is the loan interest rate fixed or variable?
• If variable, what is the maximum rate?
• At what point does interest begin accruing?
• When will I begin interest repayment?