There’s no getting around it: A college degree is expensive. More students than not end up taking out student loans to pay their tuition, but often don't fully understand the costs associated with it.
Sound familiar? As you're understanding just how interest rates work
, you're probably asking yourself, "why are my student loan interest rates so high?"
Read on to learn a little more about interest, including what is considered a high interest rate, and ways that you can get lower rates.
Why are interest rates different?
Interest rates for student loans differ for many reasons. In the first place, there's a difference between interest rates on federal student loans and those for private student loans from banks or other lending institutions.
Private student loans can sometimes have better interest rates than federal loans. That’s because they require an established and excellent credit score, proof of your ability to repay the loan, and sometimes a cosigner.
Not only do interest rates differ depending on who the lender is, but all interest rates fluctuate over time. When you look at interest rates on federal student loans over the past 15 years, for example, you’ll see they’ve ranged (depending on the type of loan) between 3.4% and 7.90%. Currently, interest for undergraduate borrowers is 2.75%, although all federal student loans have been temporarily reduced to a 0% interest rate through Dec. 31, 2020.
What is a high interest rate?
The lowest federal student loan interest rate for undergraduate borrowers is 2.75% for both direct subsidized and unsubsidized loans.
Private student loan variable interest rates can be as low as 2.13% and fixed rates as low as 3.50% but this is all dependent on your credit score and borrower history.
A lot of students will need to have their parents secure a federal Parent Plus loan to pay for education expenses not covered by other financial aid.
Unfortunately, interest for Parent Plus loans is currently a fixed rate of 5.30%. Moreover, there is the added cost of an origination fee – and Parent Plus loans are not subsidized. That last point is important. It means that interest starts the moment funds are disbursed. That interest continues running until the loan is paid in full.
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Why is my student loan interest rate so high?
College students don't usually have lots of assets or a steady source of income. In addition to this, most students are just starting to establish credit. These factors make student loans riskier to the lender.
And there's more. Unlike car loans and mortgages, these student loans are not secured by collateral. The lender has no way to easily recover their costs if the borrower fails to make payments. Lenders mitigate the risk of loaning money by charging a higher interest rate. This gives them a better chance of recouping a larger portion of their money if the borrower defaults.
How do I get a lower interest rate?
Knowing that high interest rates can mean a much higher cost for your education, it is important to find ways to get a lower interest rate when possible. There are a few options available that may help you to reduce your interest rate.
Refinance with a private loan
Once you graduate, hopefully you'll land a job that will in a relatively short time provide you with a comfortable wage. That's when you may want to consider refinancing your outstanding college debt with a private loan that has a lower interest rate. When you refinance your student loans, your new lender will pay off your other lenders and allow you to make one payment for all of the debt moving forward.
Photo by @NamNguyenHai via Twenty20
Refinancing can often save you a couple of percentage points on your interest, but you'll need to have the following:
Find out if refinancing is for you
- A good-to-excellent credit score. A score in the high 600s or higher is usually required. If you are still building your credit, consider asking a co-signer with a credit score high enough to meet the lender’s requirements.
- A solid cash flow. The lender will check to make sure that you have enough income coming in to afford your other bills along with the student loan payments.
by checking out the best refinancing options
Opt for automatic payments
If refinancing is not a possibility yet, consider other ways to shave even small amounts off your interest rates. Automatic payments are one option. Both federal loans and many private lenders will offer a discount of 0.25% off your interest rate when you sign up to have your payments automatically debited from your bank account. Talk to your lender to see if they offer this type of discount.
Look for loyalty discounts
Some lenders may also offer a discount for using other services. Your bank may offer up to a 0.25% discount on student loan interest rates if you have a checking account with them. Even the smallest discounts can add up over time. A 0.25% reduction in interest can mean up to $750 in savings on a ten-year, $30,000 loan.
In addition to looking for ways to reduce your loan's interest rate, take steps to pay down your debt faster. For example, make additional principal payments on your loan whenever you can. Put any work bonuses or tax refunds directly against your loan. If possible, increase your monthly payments, even if it's not very much. Like that 0.25% discount, it's the accumulation over time that can make small amounts meaningful.