In September 2018, the Federal Reserve increased the federal funds rate by 0.25%. That change can have an impact on student loan interest rates. If you are in the middle of taking out student loans, you may be wondering how changes in Federal Reserve rates affect them and if interest rates will be impacted by increases like this one. A more important question is why do you need to pay attention?
A Little Background – What is the federal funds rate?
Banks and credit unions are required to maintain certain levels in reserve with the Fed (or cash in vault) each night. The amount of this reserve is calculated based on the outstanding assets and liabilities of the financial institution. The federal funds rate is the interest rate banks charge each other each night if they don’t have enough in their reserve to meet the minimum requirement. Banks with a surplus can charge interest to those whose balance is lower than the minimum.
What happens to interest rates when the federal funds rate increases?
A higher federal funds rate makes it harder for banks to borrow to cover their reserve requirement. It costs more. When banks are less able to borrow money to cover their reserves, they loan less money out. The money they do lend for mortgages, credit cards, and other loans will be more expensive. The interest rate will be higher.
When does a change in the federal funds rate impact my current student loans?
Only student loans with a variable interest rate are impacted by any change to the federal funds rate. Student loans with a fixed interest rate will have that same rate forever.
What should you do if you have a variable interest rate on your student loan?
Federal student loans have fixed interest rates. The rate on an existing federal loan will not change. However, we should watch for changes in next year’s rate. Federal interest rates are changed each year in July. So, the interest rate on your federal loan next year will likely be higher if the federal funds rate increases. If necessary, federal student loans can be refinanced by private lenders, but you need to be certain to explore all of your options before doing so. (Click here for our blog about federal loan refinancing.)
Private loans are more likely to have variable interest rates. If the change is enough to make an impact on the payments you make over the life of the loan, consider refinancing. Research thoroughly and compare the total amounts you will have to pay back. Use a good calculator to factor in fees, interest rates, and terms. Sofi, Nerdwallet, and Student Loan Hero are just some of the online sites to research refinancing.
Paying attention
We can’t do anything about the Federal Reserve. 😉 If you have existing student loans, don’t forget that they can be impacted by changes to the Fed rate. Credit cards and mortgages may get more of the attention when these types of increases occur, but we can’t overlook student loans. If you are planning on borrowing in the near future, pay attention to the interest rates you are taking on. Take advantage of the fixed interest rates available with federal loans, and only use private loans to cover a small gap.
