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Do Federal Reserve rates affect student loans?

In September 2018, the Federal Reserve increased the federal funds rate by 0.25%. That change can have an impact on your client’s or their child’s student loan interest rates. If they are in the middle of taking out student loans, they may be wondering how changes in Federal Reserve rates affect them and if interest rates will be impacted by increases like this one. A more important question is why do they need to pay attention?

A Quick Review – What is the federal funds rate?

Banks and credit unions are required to maintain certain levels in reserve with the Fed (or cash in vault) each night. The amount of this reserve is calculated based on the outstanding assets and liabilities of the financial institution. The federal funds rate is the interest rate banks charge each other each night if they don’t have enough in their reserve to meet the minimum requirement. Banks with a surplus can charge interest to those whose balance is lower than the minimum.

What happens to interest rates when the federal funds rate increases?

A higher federal funds rate makes it harder for banks to borrow to cover their reserve requirement. It costs more. When banks are less able to borrow money to cover their reserves, they loan less money out. The money they do lend for mortgages, credit cards, and other loans will be more expensive. The interest rate will be higher.

When does a change in the federal funds rate impact your client’s student’s current student loans?

Only student loans with a variable interest rate are impacted by any change to the federal funds rate. Student loans with a fixed interest rate will have that same rate forever.

What should your clients do if they have a variable interest rate on their student loan?

Federal student loans have fixed interest rates. The rate on an existing federal loan will not change. However, they should watch for changes in next year’s rate. Federal interest rates are changed each year in July.  So, the interest rate on their federal loan next year will likely be higher if the federal funds rate increases. If necessary, federal student loans can be refinanced by private lenders, but your clients need to be certain to explore all of their options before doing so. 

Private loans are more likely to have variable interest rates. If the change is enough to make an impact on the payments your clients make over the life of the loan, consider refinancing. Research thoroughly and compare the total amounts they will have to pay back. Use a good calculator to factor in fees, interest rates, and terms. Sofi, Nerdwallet, and Student Loan Hero are just some of the online sites to research refinancing.

Paying attention

We can’t do anything about the Federal Reserve. 😉 If your client’s student has existing student loans, be sure to remind them that they can be impacted by changes to the Fed rate. Credit cards and mortgages may get more of the attention when these types of increases occur, but they can’t overlook student loans. If your clients  are planning on borrowing in the near future, they need to pay attention to the interest rates they are taking on. They should take advantage of the fixed interest rates available with federal loans, and only use private loans to cover a small gap.

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