How the Fed rate hike impacts student loans

Here’s What the Fed Rate Hike Means for Student Loan Rates

By SoFi General | Jan 17, 2017 | Money, student_loan | 1 Comment

One of the best things about earning a degree in the United States is that students can borrow money to go to school. One of the worst things about borrowing that money? Paying it back—with interest. And now, with the news that the Federal Reserve has increased the target range of the Federal Funds rate by 25 basis points, you’re probably starting to sweat over whether the student loan payments that already tax your budget every month will go even higher.

But instead of simply stressing and hoping for the best, you can make an informed decision about what’s right for your financial future—and we want to help., Below, we’ve identified four steps you can take to get centered and make the right move on the heels of the announcement.

Step 1: Understand the Fed rate hike

The Federal Funds rate, which is what the Fed hike refers to, is the rate banks charge one another for overnight exchange. For the last several years, the Federal Reserve has maintained an accommodating monetary policy to help revive a floundering economy. This new rate hike is only the second since 2006.

If you have federal loans, this rate increase doesn’t affect you. Federal loans, which make up 90% of all student loans in the U.S., are fixed rate loans that will not change. The remaining 10% of borrowers take out private student loans from banks and credit unions. Different interest rates are offered for different types of private loans, but only if you have a variable rate private loan will you be affected.

Variable student loan interest rates aren’t directly based on the Federal Funds rate, but they’re tied to an index, such as the LIBOR, and can change as frequently as monthly. That means your payments for variable rate private student loans can increase as the interest rates rise.

Step 2: Douse the panic

Student loans can feel like a monster you’re obligated to live with for a decade—or three. So knowledge is essential to ensure you’re not shelling out more in interest than necessary to pay for your higher education, especially in lieu of the rate hike. Be aware of the kind of student loans you have and the interest rates you’re paying on them.

If you have a variable rate loan, you’re probably panicking over the rate increase and thinking you made a bad decision. Don’t. Like you, plenty of graduates have variable rate loans, and that’s because opting for a variable rate loan was probably the smartest move at the time.

It takes time for interest rates to rise, and variable rate loans typically increase in very small increments. So, chances are, your monthly payment will increase only by a small amount. Paying a little more each month might mean fewer coffee shop indulgences, but it’s a small price to pay to maintain a loan that, in the long run, might save you money.

Think about it: Interest rates on a variable rate loan often start at 1% to 2% lower than fixed rate loans. Plus, many variable rate loans have a cap; so, no matter what happens with the federal interest rate, a borrower will never pay more than that cap. While it still might be difficult to pay more as a result of the hike, if the student loan interest rate increase is below what you would have paid for a fixed rate, then you’ve still received good deal.

Step 3: Take action—or not

If you have variable rate student loans, it’s time to ask yourself what—if anything—is the best course of action. Your answer will depend on your personal situation and flexibility. For many borrowers, the best course of action may be to do nothing at all. For others, student loan refinancing may be the wise choice.

If you choose to do nothing and keep your variable rate loans to take advantage of the maximum possible savings and have the financial flexibility to make higher monthly payments, simply make an effort to be more aware of your spending habits. By doing some solid budgeting, you can save yourself from a money crunch and maybe even plan to pay off your loans in a shorter timeframe. Ultimately, how you go about managing your day-to-day expenses can have a bigger impact on your finances than the Fed’s increase.

On the other hand, if you don’t want to worry about future interest rate hikes, want to pay a consistent monthly amount over the life of your loan, and plan to pay your loan back over a longer period of time (such as 10 to 20 years), refinancing your variable rate loans into a new fixed rate loan might be your best option.

Step 4: Think outside the student loan box

Remember, the Fed hike can affect other areas of your finances, too—namely, your credit card rates. Most credit cards operate on a variable rate, which means the interest rate hike will also increase your credit card interest rate. If you depend on plastic more than you ever anticipated as you struggle to pay your student loan debt and other monthly expenses, you might have to rethink your credit plan.

According to NerdWallet, the Fed rate hike will raise the average credit card interest paid by $17 a year, from $1,292 to $1,309. Again, that may not seem like a huge burden in the grand scheme of things, but if you have more than one credit card carrying a balance, consider applying for a card with a zero-interest balance transfer, and aggressively paying down your debt before interested is tacked on. Or, if you’re feeling especially pinched, think about paying off credit your card debt with a personal loan. SoFi offers low interest rates and fixed monthly payments on personal loans.

You don’t want to become complacent about your student loan debt or other financial obligations, but you also don’t need to dread a personal financial crisis that may never come. Remember, you’ve invested in your education, which is never a bad thing. Sure, it comes at a price, but it can be managed. Refinancing your student loans, especially in the wake of the Fed rate hike, can put you in control of your finances and save you money over the life of your loan.