How Rising Inflation Impacts your Student Loan Rates
Inflation is one of those topics that is incredibly boring, yet highly impactful for pretty much every citizen, no matter their financial status. On a high level, the US Federal Reserve’s interest rate is used as an artificial tool to manipulate inflation. As the Fed raises interest rates, the amount charged by a lender to a borrower, banks and other financial institutions tends to raise as well. Because of this increased interest cost to borrowers, consumers tend to borrow less money, spend less money, and thus decelerate inflation and the growth of the economy.
In the most simple definition, inflation is the general level of prices for goods and services rising, and consequently, the purchase power of that currency falling. There are deep connections between the respective price of student loans and the nation’s inflation rate.
According to a speech from Janet Yellen, the current President of Federal Reserve, the current inflation rate in America was at a historically low position of 1.3% in early August 2017, significantly below the original estimation of Federal Reserve. However, the Fed remains bearish that the overall inflation rate will soon stabilize near 2% due to historically low unemployment rates and the increase in core CPI. With the recent announcement that the Fed will raise the Benchmark Federal Funds rate from 1.25% to 1.50%, all indications point to the Fed continuing to raise the interest rates to 2% and potentially higher in the near future.
So what happens when inflation starts to ramp up? The first major direct impact will be on interest rates. As inflation increases, consuming power decreases, so investors need higher returns for compensation of decreases in consuming power. As a result, it is natural for an increase in interest rates, including Treasury Bonds.
When looking at federal student loan APRs, you can see the below formulas published by the Congressional Budget Office:
- Direct Undergraduate Loans: 10-Year Treasury Rate +2.05%
- Direct Graduate Loans: 10-Year Treasury Rate + 3.6%
- Direct PLUS Loans: 10-Year Treasury Rate + 4.6%
Syllogistically, as the 10-year Treasury Bond rate increases, so does the cost of federal student loans. With the expectation for inflation to rise, student loan costs will soon follow.
To further see interest rate impacts on federal flans, if we analyze the APR changes from 2016 to 2017, you can see the respective changes as follows:
- 2017–2018 Direct undergraduate loans: 4.45%, increased from 3.76%
- 2017–2018 Direct graduate loans: 6.00%, increased from 5.31%
- 2017–2018 Direct PLUS loans: 7.00%, increased from 6.31%
Since the majority of private loans are anchored as competitive offerings to federal student loans, the rising of the interest rates consequently increases the cost of all other student loans. As long as the Fed is predicting inflation to rise, it can be assumed that interest rates will rise alongside it.
Looking at a longer-term inflationary view, Janet Yellen’s term expires this month (February 2018), in which she will be immediately succeeded by Jerome Powell. Experts predict that Powell will act in continuity with Yellen with the expectation of more interest and inflation rates hikes. Although further inflation is anticipated, it will likely be a gradual controlled rise under Powell. Similar to Yellen, Powell appears a bit dovish, believing in heavily controlled rate hikes. If Powell acts as anticipated, the inflation and treasury rates should have a gradual rise throughout his tenure. For student loans costs, the predicted inflationary market of interest rates will only continue to increase the fixed APRs of students.
If we assume that the Federal Reserve can control the inflation at 2% as it plans to from its current rate of 1.8%, then the 10-year treasury will likely to increase from 1.87% to 2.3%. Based on this assumption, the APR of the direct undergraduate loan will increase to 4.75%, direct graduate loan will increase to 6.3% and direct PLUS loan will increase to 7.3%. Since we know that the private loan market has a positive correlation with Federal Student Loan prices, expect prices to correspondingly increase, according to the different assessment systems of the loan provider platforms.
Originally published at marketing.paytronage.co on February 13, 2018.
