Federal student loan interest rose July 1. Here's what to know

College education just got a little more expensive for students (and parents) who plan to take out federal loans this fall. On July 1, 2021, the Federal Reserve raised interest rates for the 2021-22 academic year by nearly a percentage point: 

• 2.75% to 3.73% for Direct Subsidized and Direct Unsubsidized loans for undergraduates.
• 4.3% to 5.28% for Direct Unsubsidized loans for graduate or professional students.
• 5.3% to 6.28% for Direct Plus loans for parents, graduate or professional students.
  

The increase comes after record-low rates from the previous year, just as the coronavirus pandemic began. The table below outlines the rates and fees for the upcoming school year. 

As you navigate the additional education costs, here are a few more things to know about federal student loans.  

Why are interest rates rising? 

Since 2013, Congress has set federal student loan interest rates based on the government's annual sale of 10-year Treasury notes. The US Treasury sells notes to investors to borrow the money needed to close the gap between received tax revenue and the amount it spends to raise capital and refinance federal debt. 

Each May, the highest bid at the T-Note auction represents the return investors receive over the next 10 years. The bid also helps investors gauge economic growth, and the student loan interest rate directly correlates to the national forecast. A slow economy lowers interest rates and makes it cheaper to borrow money for college, while a growing economy pushes rates higher and makes borrowing more expensive. 

When the pandemic began in early 2020, economic growth slowed to a halt and federal interest rates fell to an all-time low of 2.75%. This year, the Treasury note sale's high yield of 1.68% was nearly 1 percentage point (0.98%) greater than the year before, resulting in a loan rate increase.

Effects of rising rates for students and parents

A 1 percentage point rate increase translates to a few extra dollars per month in payments on a typical federal loan. The bigger impact will be felt on a loan's overall accruing interest. In particular, parents and graduate students who borrow through the Plus loan could feel additional strain when taking out money for themselves or their kids' education. This is because the Plus loan has a higher interest rate than other types of federal student loans. 

For example, let's say a parent borrows $10,000 with a Plus loan for a son's 2021 sophomore year. Excluding origination fees, that's about $5 more per month and $587 more in interest over 10 years compared with the same loan taken out in 2020. The Plus loan also allows parents and grad students to borrow for a variety of expenses, including the cost of attendance; room and board; tuition and fees; and allowances for living expenses. Of course, paying off the loan early would result in lower overall interest.

Choosing federal versus private student loans

The interest rates we've discussed so far apply only to federal student loans. The other option is to take out a loan with a private lender. Unlike government-backed funding, private lenders use a risk-based approach to set student loan terms and interest rates, which may include your credit history and score, your income, existing debt and whether you have a co-signer.

Depending on those factors, you may find a private loan with a lower fixed interest rate. Keep in mind, however, that private loans don't necessarily offer the same protections guaranteed with federal loans, including: 

• Income-sensitive repayment: Your loan may qualify for up to eight repayment options depending on how much you owe and your income post-graduation. You can also extend the 10-year repayment period to up to 30 years if lower payments suit your budget.
• Debt forgiveness: There are a few paths to debt forgiveness for federal loans. If you have an income-driven repayment plan, the government may cancel the remaining balance on a loan you've paid for 20-25 years. Many federal loans are also forgivable if you work in teaching, nonprofit or public service fields. You can learn more about federal loan forgiveness on the Federal Student Aid website. 
  
• Hardship options: Federal borrowers qualify for student loan forbearance or postponement in the event of job loss, illness, injury, returning to school or relief during a national emergency, like COVID-19.
  

How COVID-19 relief factors into the equation

You may be wondering why interest rates are increasing while the US is still dealing with a pandemic. When asked about the rate hike, a US Department of Education representative declined to comment but directed us to Federal Student Aid web pages, including Interest Rates for Direct New Loans and a page detailing how federal interest rates are calculated.

Though interest rates increased this month, the DOE extended the pause in payments and interest on all federal loans and collections on defaulted loans until at least September 30, 2021.

Last March, the DOE expanded relief efforts by offering the same zero interest pause to 1.14 million borrowers with loans in default under the Federal Family Education Loan program umbrella. Between 1965 and 2010, the FFEL program insured federal student loans disbursed by private lenders, including Stafford Loans, Unsubsidized Stafford Loans, Federal Plus Loans and Federal Consolidation Loans. While some of these loans remain private, others are held by the DOE after being transferred to the government due to default, or were purchased by the government during the 2008 financial crisis. This relief is retroactive to March 13, 2020, the DOE said in a press release and will protect more than 800,000 borrowers whose tax refunds were at risk of seizure to repay defaulted student loans. Additionally, borrowers who've had their tax refunds seized or their wages garnished over the past year will automatically receive refunds. 

If you aren't sure whether you have an FFEL loan, you can call the Federal Student Aid helpline (1-800-4-FED-AID) or log on to the FSA website with your FSA ID to learn who services your loan.