Today, a college education is a minimum requirement to get many jobs; obtaining your degree can open up countless career opportunities. That said, studying isn’t cheap. Tuition, books, and living expenses add up quickly. If you’re like many others, you will take out a student loan to help finance your (or your child’s) education.
There are a variety of loan options available to choose from and each has terms, conditions, and interest rates attached to it. Loans also differ in terms of possibilities, like consolidation and refinancing. It’s important to research these details before signing up for a loan. Student debt can impact your finances for years, so you’ll want to know just how much you will be expected to pay once you take into account the principal, interest, and other fees.
Understanding who sets interest rates and how they work will help you make informed decisions as a consumer. This guide provides an in-depth primer to student loan interest rates to get you started. Below, we cover four important elements you should know about interest before you even start looking at education loan options.
The Difference Between Federal Student Loans and Private Student Loans
The first decision you have to make when selecting a loan is whether you want to opt for a federal or a private student loan. Federal student loans are funded by the U.S. Department of Education and private student loans are funded by a diversity of private lenders. In general, it’s best to opt for a federal student loan whenever possible.
Federal student loans have lower interest rates and allow for lower monthly payments. Further, these loans better protect borrowers, thanks to benefits like income-driven repayment plans, forbearance or deferment, and more flexible forgiveness policies. Take the Public Service Loan Forgiveness (PSLF) program, for instance. This allows for the remaining balance on your student loans to be forgiven after you’ve made 120 qualifying monthly payments while working full time for an approved public service employer (e.g., nonprofits, public hospitals, school districts).
That said, federal student loans aren’t always sufficient. Read on to find out more about how federal and private student loans differ.
Federal Student Loans
Federal student loans have fixed interest rates that are set the same for all borrowers, regardless of credit history. In the wake of the COVID-19 pandemic, federal student loan interest rates are at a historic low.
The Coronavirus Aid, Relief, and Economic Security (CARES) Act initially set federal student loan interest rates at 0% through the end of September 2020. It further automatically placed all loan borrowers in administrative forbearance, allowing for a temporary stop on monthly loan repayments through the end of 2020. As of February 2021, federal student loan payments and interest rates are suspended through Sept. 30, 2021. COVID-19 is expected to further impact interest rates in the future.
Private Student Loans
Whenever possible, it’s best to opt for a federal student loan over a private one. Unlike federal loan interest rates — which are fixed — private student loans can have fixed or variable interest rates. The range of private loan interest rates is significant, ranging anywhere from 1% to 15%.
Further, private student loan interest rates vary depending on the borrower’s personal profile. An individual with a strong credit history and good credit score will be able to secure more favorable loan terms, conditions, and interest rates. That said, there is a huge diversity of loan providers to choose from, giving borrowers many options. Borrowers can compare offers from private lenders like SoFi, Discover, LendKey, and more.
The Difference Between Variable and Fixed Interest Rates
As mentioned, federal student loans are generally preferable for a number of reasons. However, a federal loan isn’t always a viable option. To get a federal student loan, you must complete the Free Application for Federal Student Aid (FAFSA). This asks about your family’s financial information and determines how much financial aid for which you are eligible. Depending on your financial need, it may be that the amount you are eligible for isn’t enough to cover all of your costs.
In this case, you may have to turn to private lenders. (Note that many people opt to do both, getting a federal loan program to cover part of their costs and then getting private loans to cover the remainder.) When you start looking at private lenders, you’ll be faced with the next point: variable versus fixed rate interest loans. Find out how they differ below.
Variable Rate Loans
Variable interest rates aren’t set in stone and fluctuate over time. The rate may change on a monthly or quarterly basis, depending on the loan contract. In general, a variable interest rate loan is riskier than a fixed interest loan. You can’t precisely predict how the rate will change. The lack of predictability leads to uncertainty and a lack of security that may deter some borrowers.
Further, while there are interest rate caps, these can be quite high — as much as 25%. That said, in some cases, variable interest loans can save you money. It’s all a question of timing. For example, interest rates are generally low across the board right now; for some people, it’s a good time to take out a loan.
Fixed Interest Loans
When an interest rate is fixed, it doesn’t change during the loan’s lifetime. Again, all federal student loans have fixed interest rates. However, private lenders usually offer both fixed and variable interest rate loans. Fixed interest rates are generally considered safer because they are predictable. You don’t have to worry about fluctuations and potential volatility, which can result in higher interest rates and, thus, higher monthly payments.
Although they offer added safety and certainty, fixed interest rates do have some drawbacks compared to variable interest rates. In general, lenders set fixed interest rates higher because they can’t potentially benefit from market fluctuations down the line. You are also more likely to miss out on potential market dips in rates.
How Student Loan Interest Rates Work
Student loan interest rates function differently depending on whether they are federal or private. Read on for a brief overview of how federal versus private student loan interest rates work and an overview of current rates.
Federal Student Loan Interest Rates
Federal student loan interest rates are fixed for the life of the loan. Most federal loans also have fees attached to them, calculated as a percentage rate of the loan amount. The interest rates for federal student loans are set annually by Congress and based on the 10-year Treasury note.
Interest rates for federal student loans as of February 2021 are as follows:
- Direct Subsidized Loans and Unsubsidized Loans for undergraduate borrowers: 2.75% fixed APR
- Direct Unsubsidized Loans for graduate or professional students: 4.30% APR
- Direct PLUS Loans for parents and graduate or professional borrowers: 5.30% APR
As mentioned, the COVID-19 pandemic has already had an impact on student loan interest rates and this is likely to continue. For now, payments and interest rates are suspended through Sept. 30, 2021, for federal loans thanks to the automatic forbearance instituted by the government. It’s up to borrowers whether they want to take advantage of this option.
Private Student Loan Interest Rates
Private student loan interest rates may be fixed or variable. The interest rates are set by each private lender. The rates are further determined based on the financial profile of the borrower, taking into account factors like credit history and current income. Variable rates will change quarterly or monthly.
Some interest rates for private loans as of February 2021 are as follows:
- College Ave: Fixed 3.34%–12.99% APR; variable 1.04%–11.98% APR
- CommonBond: Fixed 3.74%–10.74% APR; variable 3.81%–9.37% APR
- SoFi: Fixed 4.23%–11.26% APR; variable 1.87%–11.66% APR
This is just a small sample of lenders and interest rates. There are many other private lenders to choose from. The COVID-19 pandemic has also had some impact on private student loan interest rates, as private lenders have adapted to the cuts in federal rates.
How Refinancing and Consolidation Rates Work
Student loans run for long periods, with terms usually starting at five years. Many things can change in this amount of time, from your personal income to market interest rates. If you want to make adjustments to your loans and what you pay, you may consider refinancing or consolidation.
You may be able to consolidate federal student loans (or, in some cases, refinance them with a private lender — however, this means losing federal loan protection and benefits). For private loans, you may be able to refinance with the same lender or a new one.
Federal Consolidation Rates
If you have multiple federal student loans, you may be able to streamline your student loan debt through consolidation. If you have multiple student loans with various rates and consolidate them through the federal government, the weighted average interest rate, rounded up to the nearest .125%, will be the rate you’ll get. You will then have one payment per month under your new consolidation loan instead of multiple monthly payments.
Student loan refinancing can save you money by replacing existing debt with a lower-cost loan. To qualify for refinancing, you’ll usually need a good credit score (at least in the high 600s) and a demonstrated steady income. If you can’t meet these criteria, you may be able to refinance by getting a co-signer on your loan. Different lenders have different eligibility criteria for refinancing and not all loans can be refinanced.
Here are some student loan refinance rates as of February 2021 to give you an idea of what this might look like. Again, this isn’t an exhaustive list and these numbers will change over time:
- SoFi: Fixed 2.99%–5.59% APR; variable 2.25%–5.14% APR
- LendKey: Fixed 2.95%–7.63% APR; variable 1.91%–5.25% APR
- Laurel Road: Fixed 2.80%–6.00% APR; variable 1.89%–5.90% APR
We’re Here to Help You Find the Best Student Loan Interest Rate
Navigating the complex environment of student loans can be daunting at first glance. However, it doesn’t have to be difficult. Before you start looking at loan options, do your research into the basics of student loans — like how interest rates work. Once you have a handle on the mechanics of private versus federal student loans, you’ll be able to make better decisions as to which option is best for you.
CollegeFinance.com is here to help. We offer comprehensive resources providing information about loan options, conditions, and rates. Our resources also cover topics that impact your loans, like COVID-19. Our aim is to help borrowers understand loans so they can make smart choices about their finances.
FAQ: Student Loan Interest Rates
What Is the Current Interest Rate for Student Loans?
Interest rates for federal student loans are at a historic low. As of February 2021, the rate for federal Direct Subsidized and Direct Unsubsidized Loans for undergraduate borrowers is 2.75% fixed APR. The rate for Direct Unsubsidized Loans for graduate students and professional borrowers is 4.35% fixed APR. The rate for PLUS loans for parents and graduates or professionals is 5.30% APR.
In many cases, the 2021 interest rates for private lenders have been slashed in response to the federal interest cuts and COVID-19 economic fallout. However, private student loan interest rates remain highly variable and depend on the lender and the borrower’s profile (e.g., credit history, employment, etc.).
How Can I Avoid Paying Interest on Student Loans?
The best way to avoid high interest student loans is to opt for a federal student loan. Interest rates on federal loans are generally lower and offer more flexibility. For example, you can consider income-driven repayment options. If your payments aren’t enough to cover the interest on Stafford Loans (another name for Direct Loans), the government may pay the difference for up to three years.
You can also inquire regarding student loan deferment, which will suspend principal payments and interest payments. If you aren’t eligible for deferment, forbearance is an option. This likewise allows you to temporarily suspend payments. In either case you will still accumulate interest.
Should I Pay Off the Principal or Interest First on Student Loans?
Ideally, you should pay off both the principal and interest on your student loans every month. If you run into financial troubles, however, this may not be an option. Some loan plans allow you to put off paying the principal balance while you are still studying. If you have to decide between paying the principal or interest, focus on paying the interest as frequently as possible. You will end up paying less on your loans over time if you can pay down the interest while you’re still studying.