When we think about inflation, rising gas prices or higher grocery bills usually come to mind.
Sadly, inflation often means higher interest rates for student loan borrowers.
The good news is that borrowers can prevent inflation from impacting their student loan bills. The strategy will depend upon what type of student loans you have.
How Inflation Impacts Student Loans
During times of inflation, the prices of goods and services increase. One way the government can fight inflation is for the Federal Reserve to raise interest rates.
When the Fed raises interest rates, it impacts interest rates across the economy. This means higher interest rates on mortgages, car loans, and student loans.
Fortunately, these changes only impact some student loan borrowers. If you have a fixed-rate loan, your interest rate does not move. If you have a variable-rate loan, your interest rate will almost certainly increase.
Digging Deeper: Inflation can be helpful for some borrowers and harm others. Learn how changing economic conditions impact student loan borrowers.
Inflation for Federal Borrowers
Dating back to the fall of 2006, all federal student loans issued come with fixed rates. If you have a fixed-rate federal loan, it means inflation will not impact your monthly student loan payments.
However, if you have a federal student loan from the Spring of 2006 or earlier, your loan has a variable interest rate.
Preventing interest rate increases from inflation is relatively easy. Federal direct consolidation eliminates variable-rate loans and replaces the debt with a new fixed-rate loan. This means borrowers can lock in their current low interest rates permanently.
However, it is worth noting that consolidation impacts more than just your interest rate. Consolidation can help or hurt program eligibility, including student loan forgiveness. Be sure you understand the consequences of consolidation before starting the process.
Private Student Loans, Inflation, and Rising Interest Rates
Like with federal loans, if you have a fixed-rate loan, you are in the clear.
Unfortunately, variable-rate loans are far more common with private lenders. Worse yet, preventing interest rate increases due to inflation is more difficult.
Borrowers have two main options to prevent interest rate increases on their private loans:
- Option 1: Pay off the loan balance in full. Writing the big check isn’t an option for most borrowers. However, if you have been delaying paying off your loans to pursue other financial goals, now might be the time to knock out your variable-rate loans.
- Option 2: Refinance with a fixed-rate loan. When you refinance, you find a new lender who issues a fixed-rate loan. That fixed-rate loan is used to elimiante your variable-rate loans. It is a great way to prevent interest rate increases, but borrowers will need a good credit score and income to qualify.
If you are refinancing to prevent inflation from impacting your interest rates, two strategies are used.
Some borrowers want the lowest fixed rate possible. This usually means a 5-year fixed-rate loan. The downside to this strategy is that higher monthly payments are required to pay off the loan in just five years.
As of March 2022, the following lenders advertise the lowest rates on 5-year fixed-rate loans:
If you want to lock in a fixed rate and keep monthly payments manageable, a 20-year fixed-rate loan is often the best choice. The starting interest rates are usually slightly higher, but the monthly bill is much lower due to the extended repayment length.
As of March 2022, the following lenders advertise the lowest rates on 20-year fixed-rate loans:
Finally, it is essential to note that the lenders advertising the lowest interest rates may not actually offer the lowest interest rate. Each lender uses a different formula for deciding the rates borrowers receive. One lender may consider you a risky bet and offer a high rate while another loves your credit profile and offers a lower rate. Shopping around for the best rate is essential.
What if interest rates drop in the future? Don’t worry about waiting until the rates are at the lowest possible. Unlike a mortgage, where refinancing can cost thousands of dollars, the only cost to refinancing student loans is your time.
You can refinance now, and if rates drop in a few months, refinance again. There really isn’t a harm to refinancing your student loans multiple times.
Minimizing the Damage of Inflation to your Student Loans
Some borrowers don’t have the option of refinancing to prevent interest rate increases.
If you fall into this category, it is still possible to take steps to minimize the damage caused by inflation. For most borrowers, this means focusing your efforts on eliminating your variable-rate student loans first.
For example, many borrowers choose to pay down a loan with a 5% fixed interest rate before attacking a loan with a 4% variable interest rate. However, if you fear inflation will cause the variable-rate loan to jump dramatically, you should focus on eliminating the variable-rate loan first.
Additionally, there is a long list of strategies that borrowers can use to lower interest rates.