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Thursday, 01 August, 2013

Student Loan Rate Changes & the 10 Year US Treasury – What You Need to Know

A new student loan bill has passed Congress and is set to be signed into law by President Obama. Under the new rules, future student loan rates will be linked to the cost of government borrowing as measured by the 10 Year US Treasury Note. This is a dramatic yet not unrealistic departure from the way student loan interest rates were historically set (ie. an arbitrary borrowing rate set by Congress).

For current year borrowers with loans issued after July 1st, student loan rates will be lower than rates previously available:

  • Undergraduate Stafford Loans will have an interest rate of 3.86%
  • Graduate Stafford Loans will have an interest rate of 5.4%
  • PLUS loans will have an interest rate of 6.4%

Under the new rules, rates will be fixed over the life of the loan with the rates varying each year for new loan issues. Most importantly, the new methodology for setting future student loan rates will be calculated as outlined below:

  • Undergraduate Stafford Loans Rate = 10 Year Treasury + 2.05%; CAP of 8.25%
  • Graduate Stafford Loans Rate = 10 Year Treasury + 3.6%; CAP of 9.5%
  • PLUS Loans Rate = 10 Year Treasury + 4.6%; CAP of 10.5%

The new methodology is designed to reduce the level of subsidized interest paid by taxpayers. However, given the low level of interest rates today and the expectation that rates will rise in the future, these changes may represent a significant challenge for student and parent borrowers in the future. For example, an Undergraduate Stafford Loan issued based on today’s 10 Year Treasury would charge 4.74% annually, almost +1% higher than only 3 months ago. Further interest rate increases and a subsequent rise in the 10 Year Treasury yield will likely mean an increase in monthly student loan payments of potentially hundreds of dollars.

With persistently high levels of unemployment and a three year student loan default rate of 13%, a further increase in rates may put a larger percentage of future graduates at risk. Parents and students need to assess these risks in the context of a longer term financial plan and prepare for the inevitable rise in rates and the associated higher monthly loan payments at graduation.

Posted By:  LiamTimmons - Thursday, 01 August, 2013 at 12:00 AM

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