Student loan interest rates are particularly high right now, with the rates on federal undergraduate loans reaching a near-record high of 6.53%. There are several factors contributing to this. While some of these are specific to either federal or private student loans, one factor affecting both loan types is volatile market conditions. Learn more about why student loan rates are so high and the factors that contribute to high interest rates.
Key Takeaways
- With both federal and private student loans, interest rates increase and decrease alongside rates on other types of loans.
- Congress sets interest rates on federal student loans every year, using rates on 10-year Treasury notes as a guideline.
- Student loans from private companies offer fixed or variable rates that rise and fall based on market conditions.
Understanding Student Loans
In order to fully unpack why student loan interest rates are so high, it’s important to first understand the differences between federal and private student loans.
- Federal student loans: Federal student loans are funded by the federal government and feature fixed interest rates that don’t change for the life of the loan. Repayment can last from 10 to 30 years depending on the loan type and chosen term, and there are even income-driven repayment (IDR) plans for federal loans that base payments on income and family size. Some federal student loans feature subsidized interest while you’re in college, meaning interest doesn’t accrue on unpaid loan amounts until after graduation. Note that Congress sets interest rates on federal student loans every year using rates on 10-year Treasury notes as a guideline.
- Private student loans: Private student loans are issued by banks, credit unions, and other financial institutions that typically set their interest rates based on market conditions. Repayment options and loan terms will vary, and most companies offer both fixed and variable interest rates. Note that private student loans are never subsidized, meaning the government will never cover your interest payments while you're in school.
Federal Student Loan Rates
While interest rates on private student loans can change frequently and vary widely, the following rates are fixed for federal student loans disbursed after July 1, 2024, and before July 1, 2025.
| Loan Type | Borrower Type | Fixed Interest Rate |
|---|---|---|
| Direct subsidized loans and direct unsubsidized loans | Undergraduate | 6.53% |
| Direct unsubsidized loans | Graduate or professional | 8.08% |
| Direct PLUS loans | Parents and graduate or professional students | 9.08% |
Factors Contributing to High Interest Rates
Federal Student Loans
We mentioned that Congress sets interest rates on federal student loans using rates on 10-year Treasury notes as a guideline, but how are those rates set? The government sets rates for 10-year Treasury notes based on the current economic landscape and global market conditions, but rates are also partially set using a bidding system.
When market conditions are unreliable and investors are looking for a safe place to store their money, rates for 10-year Treasury notes tend to increase. Meanwhile, these same rates tend to decrease when markets are less volatile and demand slows down.
Due to the passage of the Higher Education Act of 1965, interest rates are set each spring for new direct loans being made for the upcoming award year (from July 1 to the following June 30).
Private Student Loans
Private student loan rates are also set based on market conditions, and they can be variable or fixed. The interest rates on private student loans depend on the lender and loan details, including loan amount, repayment term, and the borrower's income and credit score.
In contrast to private student loans, most federal student loans don’t require a credit check and offer the same fixed interest rates to all borrowers regardless of their financial situation.
Economic Influences
Interest rates are higher compared to several years ago for nearly any type of loan, from auto loans to mortgages. Rising interest rates are directly correlated to Federal Reserve increases in the federal funds rate, which is the rate banks pay one another when they borrow money.
While the Fed has raised and lowered the federal funds rate regularly over time, 11 separate rate increases took place throughout 2022 and 2023 in response to market conditions and heightened inflation in the United States.
Do Private Student Loans Have Lower Interest Rates Than Federal Loans?
Private student loan rates may be higher or lower than rates on federal student loans. It depends on the rates being offered by private lenders, a borrower's income and credit score, and the loan terms.
How Do Interest Rates for Graduate and Professional Degrees Compare to Undergraduate Rates?
Current rates on direct PLUS loans for parents and graduate and professional students are set at 9.08%, compared to the 6.53% rate that applies to direct subsidized loans and direct unsubsidized loans for undergraduate students.
How Does My Credit Score Determine Private Student Loan Interest Rates?
Private student lenders require applicants to pass a credit check to be approved, and they set rates based on creditworthiness and income. Individuals with good or excellent credit (or a qualified co-signer) can qualify for lower interest rates, whereas those with less-than-stellar credit typically pay higher interest rates.
What Can I Do to Pay Off My Student Loan Faster?
You can pay off your student loans faster by refinancing to a new loan with a shorter repayment term, making additional payments toward the principal, or both.
The Bottom Line
Student loan interest rates are so high right now compared to just a few years ago, similar to mortgage loans, auto loans, personal loans, and other types of commercial lending. This is especially troubling for federal student loans, as they're fixed for the loan duration, and refinancing with a private lender to hopefully secure a lower rate would mean losing out on several federal protections and benefits.
Ultimately, students should borrow with a plan in mind regardless of interest rates. It may make more sense to refinance student loans when rates drop or make larger monthly payments to pay down debt faster.
Article Sources
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Federal Student Aid. "Interest Rates and Fees for Federal Student Loans."
Federal Student Aid. "Federal Versus Private Loans."
Sallie Mae. "Understanding Federal Loan Interest Rates."
TreasuryDirect. “Understanding Pricing and Interest Rates.”
GovInfo. “Higher Education Act of 1965.”
Board of Governors of the Federal Reserve System. "Open Market Operations."
