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Keeping it Interesting

May 30, 2018
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The economy is one topic that stays relevant and is regularly a subject of news stories.  Closely related is the topic of interest rates.  Without going into a long discourse on economic conditions or policy, suffice it to say that interest rates have a significant impact on the economy.  And, with student loans now reportedly to have grown to be a $1.4 trillion[i] segment of the debt of the population of the United States as of the end of last year, the interest rates applied to student loans is of interest to a large segment of people.

 

The interest rate for all loans made after July 1, 2013, is set at a fixed rate.  This rate structure was implemented with the Bipartisan Student Loan Certainty Act of 2013, which overhauled the Federal Direct Student Loan Programs’ interest rate structure.  The result of that Act is that interest rates are now determined based upon the high yield of the last auction of the 10-year Treasury notes held prior to June 1 each year.  That yield becomes the “index” in the interest rate formula.  A margin, or what is called an “add on,” is attached to the index to generate the final interest rate for loans made in the new award year.  The rates for the Subsidized and Unsubsidized Direct Loans to undergraduate students are at equal interest rates based upon this formula, as opposed to the former structure that generated different rates for the Subsidized and Unsubsidized loans.  Also, the law calculates the interest differently for Direct Unsubsidized Loans for graduate/professional level students, as well as for Graduate PLUS Loans and Parent PLUS Loans.  The result is that each of the categories of loans is at a unique rate.

The rate is applicable to all loans taken out during an award year.  That is, all loans of the same type that are disbursed from July 1 of one calendar year through June 30 of the next calendar year are all made with the same interest rate.  However, to keep things interesting, due to an ever changing economy, loans borrowed in each award year will likely have a different interest rate than that of the prior year and each subsequent year.  The loans to be borrowed (disbursed) in the award year of July 1, 2018, through June 30, 2019, are no exception.  And, it is of note that interest rate is rising again for 2018-2019.

The last auction of the 10-year Treasury note prior to June 1 this year was held on May 9, 2018.  The high yield at that auction was 2.995%.[2]  That yield rate is used to determine the rates on new loans first disbursed on or after July 1, 2018.

The U.S. Department of Education (ED) announced the interest rates for loans to be disbursed on or after July 1, 2018, but before July 1, 2019, in an Electronic Announcement on May 18, 2018.[3]  Consequently, the interest rates for such new loans to be first disbursed on or after July 1, 2018, but before July 1, 2019, will be as shown in the chart below.  The interest rate on these loans is fixed at the rate that is valid when a loan is disbursed and, therefore applies to that loan for the life of the loan.

 

Again, the rates in the chart are a fixed rate for any loan made during the time period beginning with a disbursement on or after July 1, 2018, and before July 1, 2019.  Students with loans prior to this period may have different rates on such former loans as likely, also, will borrowers who take out loans after this defined 2018-2019 award year period.

Noticeably absent in the chart is any indication of rates for Federal Direct Consolidation Loans.  Any Direct Consolidation Loan (DCL) application that is received on or after July 1, 2013, has the rate calculated based upon a weighted average of the interest rates of the loans being consolidated, rounded up to the nearest 1/8 of one percent.  Therefore, Direct Consolidation Loans are not covered, specifically, by the new interest rate structure highlighted in the chart above.  Rather, the DCL interest rate is affected by the effect the individual loans’ rates have on determining the weighted average rate of the loans being consolidated.  This, thereby, impacts the new DCL’s interest rate.  Of note, also, is that DCLs do not have a cap or maximum on their interest rates.  Rather, as stated, the rates on DCLs are calculated based upon the weighted average of the loans consolidated.

Further, it is important to keep in mind that for students who borrowed prior to July 1, 2013, the interest rate structure was different.  So, a student who borrowed previously may have loans with an interest rate calculated on a different basis, or that was otherwise established by law at the time.  Borrowers who obtained loans under the former Federal Family Education Loan Program (FFELP), with loans disbursed prior to June 30, 2010, may have various loans using a number of different formulas.  (Annually, ED publishes a chart of such prior FFELP loan interest rates that are currently applicable.  These charts are typically released the end of May, and may be updated again at the end of June.)

What is the key point in this news from ED?  While the overall economic news in the country is looking more favorable, interest rates are impacted.  This is evidenced, in part, with the Treasury auction in May.  Rising interest rates can be good for saving and investing purposes.  But, as a result also, the interest rates on student loans for the 2018-2019 award year will rise over the rates for 2017-2018 loans—an increase of 60 basis points, or 0.6 percent.

Although loans for this year are fixed at the rates listed in the chart above, rates for loans in a student’s future years can be different, which may be more or less favorable to the borrower.  (For example, rates for 2018-2019 Direct Loans will be 1.29% higher than they were two years ago in 2016-2017.)   As always, while student loans may be a useful tool to assist in paying for higher education, borrowers should use discretion when deciding an amount to borrow to avoid paying more interest than necessary over the life of a loan.

[1] Board of Governors of the Federal Reserve System, March 2018, released: May 7, 2018 at https://www.federalreserve.gov/releases/g19/current/

[2] Treasury News, U.S. Department of the Treasury, May 09, 2018, at https://www.treasurydirect.gov/instit/annceresult/press/preanre/2018/R_20180509_1.pdf

[3] Electronic Announcement, U.S. Department of Education, May 18, 2018, at https://ifap.ed.gov/eannouncements/051818InterRatesforDLFirstDisbursedBetw070118and063019.html

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This material is presented for informational and educational purposes only and should not be considered to be giving legal advice.

 

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