Federal Student Loan Interest Rates Drop to Historic Lows

By Joe Messinger, CFP®

June 26, 2020

3 min READ

Every July 1st, federal student loan interest rates are adjusted for the upcoming year. In 2020, those rates will drop to historic levels. Why did this happen? What does this mean for families?

Effective July 1, 2020, The new federal student loans rate for undergraduates will drop from 4.53% last year to 2.75%. Rates for graduate students (4.3% down from 6.08%) and Parent PLUS (5.3% down from 7.08%) are also decreasing. (Need an update on how loans work? Click here.)

These interest rates will apply to federal student loans taken out between the period 7/1/20 to 6/30/21. These rates do not apply to private loans.

Why did they drop so low?

The federal student loan interest rates are determined using a formula based on the high yield of the 10-year treasury note auction held each May. Falling bond yields means the government can borrow more cheaply and pass on that savings. COVID-19 caused an economic downturn.

The formula is:

• Undergraduate direct loans = 10-year treasury yield plus add-on of 2.05%
• Graduate direct loans = 10-year treasury yield plus add-on of 3.6%
• Parent and Graduate PLUS loans = 10-year treasury yield plus add-on of 4.6%
• Note: Congress has capped rates at 8.25%, 9.5%, and 10.5% respectively.

Private loans also follow treasury note yield, but they reflect a borrower’s ability to repay the loan and their credit rating. They will probably not drop as low as the federal rates.

What does this mean for families?

For families with EXISTING student loans, it doesn’t mean much. Federal loans do not offer a refinancing option like private loans do. You can refinance federal loans INTO a private loan. You would only choose this option if you have good credit and the interest and fees are better than what you are currently paying. Note that federal loans have certain benefits that private loans do not offer. For example, at the time of this writing, COVID-19 has caused the government to pass the CARES Act to provide a special 0% interest period and temporary forbearance of payments until 9/30/20 for current loan holders. Private loans also do not provide income based repayment options.

For families looking to OPEN student loans this coming year, you will see some savings, but it might not be as much as you expect. For every $10,000 borrowed, you can expect to save $100 per year in interest or $1,000 for a typical 10 year repayment term. While saving $1,000 is still great news, families might be surprised that it isn’t a more substantial sum.

We like to advise our families to plan out how they will pay for college across all four years before they even get started. If you are looking at taking out federal loans in future years that you weren’t planning on at this time, maybe you flip that plan and take out the loan this year instead. We anticipate that the economy will continue to improve, and rates will begin to rise again in the future. You can take advantage of this year’s “sale” price if loans were going to be a part of the future picture.

As a result of current market conditions, some families saw a loss in their financial investments that they were planning on using to pay for college. If your investment lost money, you may want to wait for those investments to rebound and take out a small loan at this time. This choice requires careful weighing of the investment’s loss and the potential total interest you would pay on a loan.

So good news but not great news!

The decrease in the federal student loan interest rates is good news. However, it might not be the great news families expect it to be. We’ll take the savings wherever we can get it though.