Student loan rates set to rise

By Chris HorymskiConsumer Reports

Certain types of federal student loans will cost borrowers more beginning next month, as their interest rates adjust to reflect the higher borrowing costs of the federal government.

This will be the first full year that the market, instead of Congress, determines the borrowing rate of federal student loans. In previous years, Congress and the Obama administration squared off over which rate students would be charged to borrow from the federal government. The Obama administration preferred keeping rates at 3.4 percent, while the Republican-controlled House of Representatives insisted on letting the existing legislation at the time expire, which would have effectively led to a 6.8 percent borrowing rate for students.

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The compromise, reached last August, was to let the market determine what rates would be by tying student loan rates to government borrowing costs, as measured by the market price of the 10-year Treasury notes it sells (the government, after all, makes interest payments while the student remains in college). The formula for determining student loan borrowing rates for Stafford Loans, for example, adds 2.05 percentage points to the 10-year Treasury note rate. In mid-2013, the 10-year yield was a rock-bottom 1.81 percent, so students borrowing for that academic year will be paying that loan back at a rate of 3.86 percent.

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But since Treasury rates have gone up since, to 2.61 percent, undergraduate students borrowing for the 2014 academic year will be borrowing at a higher rate: 4.66 percent. Graduate students and borrowers of PLUS loans will paying even more: 6.21 and 7.21 percent, respectively. Although the rates depend on the 10-year Treasury, the rates are fixed; borrowers will repay at that rate for the life of the loan. You can find the current rates at the Department of Education's Federal Student Aid website.

It's likely that the 10-year rates will continue to rise. Although we can't know for sure what the rates will be, the futures markets imply that the rate will be higher still: according to a recent Wall Street Journal survey of economists, the consensus calls for yields of 10-year treasury notes to increase to 3.47 percent, which would mean student loans with an interest rate of at least 5.52 percent in the 2015 academic year.

Chris Horymski

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