Coming off the first interest rate hike since 2018, investors may have many questions. In particular, what this interest rate hike means for individuals is of utmost importance to many investors. Specifically, many may wonder what the Fed rate hike means for student loans.
Rising interest rates impact all loans, but not in the way many investors may think. The Federal Reserve raised the benchmark rate from near-zero levels for the first time since the onset of the pandemic. However, this overnight lending rate doesn’t really impact anything other than the short-term rates used to determine what banks pay to each other for ultra-short-term investments such as commercial paper or Treasury bills.
For student loan debt, much like mortgages, it’s longer-dated bonds that really matter.
Let’s dive into what investors should consider when it comes to student loan debt right now.
How the Fed Rate Hike Impacts Student Loans
It’s probably important to start with the fact that most folks with existing student loans won’t be impacted by the Fed rate hike decision we saw on Wednesday. That’s because federal student loans carry a fixed interest rate, which is set at the time of borrowing. The rate for any new federal loans (after July 1) is tied to the 10-year U.S. Treasury yield, which does change from time to time.
For those who locked in their student loans already, there’s really nothing that’s going to change. However, for those looking to borrow more to fund their education, or who will be heading into post-secondary education shortly, higher bond yields are affecting student loan rates. Additionally, some private student debt (over and above federal loans) can carry variable interest rates. For those with a variable rate, payments are likely to increase.
That’s because since the beginning of March, bonds across the yield curve have been on the rise. The 10-year U.S. Treasury yield has risen from 1.72% to 2.2% in the span of less than three weeks.
Much of this is driven by expectations that interest rates are likely to remain higher for longer, as a result of inflation and a more hawkish Fed. Generally speaking, longer-dated bonds tend to have higher yields than short-dated bonds. Thus, when the short end of the curve increases due to Fed rate hikes, longer-dated bonds tend to follow.
Various experts suggest that the new rate on student loans could be between 4% and 4.5%. That’s up from rates of approximately 3.7% right now.
Pricier borrowing has led to a widespread expectation the President Joe Biden’s administration may choose to extend the deferral period for student loans further. This expectation has impacted companies in the student loan lending space, such as SoFi (NASDAQ:SOFI) of late. Accordingly, investors have a number of factors to consider on top of their own personal student loan rates.
On the date of publication, Chris MacDonald did not have (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.
