Inflation indirectly causes student loan interest rates to rise. That’s because the government tends to increase interest rates to combat rising prices, which typically raises the cost of borrowing.
Student loan interest rates have in fact risen since the Federal Reserve began raising interest rates to combat inflation during the Covid-19 economic recovery. For example, the fixed interest rate on newly disbursed federal student loans for undergraduates went from 2.75% in July 2020 to 5.50% in July 2023.
The fixed interest rate on newly disbursed federal student loans is largely determined by the high yield of the final 10-year Treasury note auction held each year in May. Bond yields are typically higher when interest rates go up.
High inflation is bad news for people seeking new student loans and those with variable interest rate loans, though people with fixed-rate loans won’t see their rates go up.
What Exactly Is Inflation?
Inflation — the rising cost of everyday items — is an important economic factor to everyone from investors to policymakers to borrowers. The reason it matters to borrowers is that inflation can lead to higher interest rates on every kind of debt, including student loans.
Put simply, inflation means that the price of bread will be higher tomorrow than it is today. So lenders may increase their interest rates during times of high inflation, given that borrowers will be paying the money back when those dollars will buy less. That’s one reason inflation and many interest rates have typically risen or fallen in step with each other.
The Federal Reserve is another reason. The country’s central bank plays a major role in managing the economy, especially with factors like interest rates and inflation.
The Fed began its rate-hiking campaign in March 2022 to combat high inflation and continued raising rates into 2023. Increases to the federal funds rate have prompted commercial banks to raise the price of consumer loans and other financial products, including private student loans.
What Does Inflation Mean for Student Loans?
To someone with student loan debt, inflation may not always be bad news. That’s because price inflation may influence wage inflation.
Inflation typically drives up the price of everything, including wages. As a result, some borrowers are paying back certain fixed-rate loans, for example, with dollars that have less value than the ones they borrowed.
There are exceptions. If a borrower took out a variable rate private student loan, it’s likely that inflation will lead to higher interest rates, which will translate into higher interest rates that the borrower has to pay. But if the borrower has a fixed-rate private student loan and their salary keeps up with the pace of inflation, then inflation can be helpful.
With the Federal Reserve in 2023 still aiming to cool down inflation or Consumer Price Index (CPI) growth, it’s worth checking to see whether your private student loan has a fixed or variable rate.
As a quick primer, fixed-rate loans have the same interest rate from when borrowers take out the loan to when they pay it off. Variable-rate loans change the interest they charge, which is influenced by Federal Reserve rate changes.
Variable-rate loans, also sometimes called “floating rate” loans, usually start out with lower interest rates than fixed-rate loans.
All federal student loans disbursed since July 2006 have fixed interest rates. Meanwhile, banks and other private lenders may offer fixed-rate and variable-rate private student loans.
When Does Refinancing Make Sense?
Student loan refinancing may be right for you if you qualify for a lower interest rate. Refinancing federal student loans with a private lender would remove your access to federal income-driven repayment (IDR) plans and Public Service Loan Forgiveness (PSLF). A student loan refinancing calculator may come in handy as you weigh your options.
The first step is to check the interest rates on your existing student loans against the rates offered by other lenders. If they offer a better rate, then it may be possible to pay off that student loan debt faster or reduce your monthly payments with refinancing.
Some lenders refinance both federal and private student loans. If you choose to refinance federal student loans with a private lender, realize that you will give up federal benefits and protections like IDR plans and PSLF.
After a three-year pause, interest accrual on federal student loans will resume on Sept. 1, 2023, and payments will be due starting in October 2023. If you qualify for a lower interest rate, student loan refinancing may reduce your borrowing costs. Refinancing for a longer term, however, may increase your total interest costs.
Recommended: SAVE Plan for Federal Student Loans
The Takeaway
Borrowers with variable-rate student loans may see their borrowing costs go up during times of rising inflation. Whether your student loans have a fixed or variable interest rate, the impact of consumer price inflation across the economy may impact your ability to make ends meet.
If you find student loan refinancing is right for you, SoFi can help. SoFi refinances federal student loans, parent PLUS loans, and private student loans with no origination or prepayment fees.
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