Many borrowers with student loans haven't made any payments for more than two years, and we certainly can't blame them. After all, the United States Department of Education put several relief measures for the COVID-19 pandemic into place in March of 2020, including pausing all payments on federal student loans and fixing interest rates at 0%.
This original deferment period was only meant to last for several months, but it has been extended multiple times since those early days. At the moment, the emergency measures are set to expire on Dec. 31, 2022. This means that borrowers with federal student loans will have to pick up where they left off with their debt and payments come Jan. 1, 2023.
Either way, a lot has happened with the economy over the last two years. One of the biggest changes has come in the form of inflation, which is currently rising at a rapid pace.
The Consumer Price Index (CPI), which is used to measure the price of various goods and services over time, increased 8.5% year-over-year (YOY). With that in mind, it's perfectly reasonable to wonder how inflation might affect student loans in general. Read on to learn why inflation matters when it comes to student debt, where problems may arise, and what you can do about it, if anything.
- In March of 2020, the U.S. Department of Education announced an emergency deferment of eligible federal student loans due to the pandemic. This emergency measure included paused payments on eligible federal student loans, as well as a fixed interest rate of 0%.
- The deferment period is currently scheduled to expire on Dec. 31, 2022, although the emergency measure could always be extended again before then. If it's not extended again, borrowers with federal student loans will have to make payments again after Jan. 1, 2023.
- Inflation has increased dramatically so far in 2022. In fact, the Consumer Price Index increased 8.5% in July of 2022 over the year before.
- Some borrowers are bracing for impacts on their student loans due to inflation, such as rising interest rates and having less disposable income to make payments.
Increasing Rates for Federal Student Loans
The Fed increased rates in March, May, June, and July of 2022. These rate increases were explained as a way to help combat and ultimately stifle inflation. It is possible that more rate increases will happen.
In the meantime, rising rates make borrowing more costly in general, whether you have a credit card balance or you're taking out a personal loan. Federal student loans with fixed interest rates will also feel the impact of this rate increase, although the rising rates will only affect borrowers who take out student loans in the future.
How much are the rates for federal student loans going up? The chart below illustrates the current fixed interest rates for several types of federal student loans compared to what students will pay next year.
|Loan Type||Borrower Type||Fixed Interest Rate for Direct Loans First Disbursed on or After July 1, 2021, and Before July 1, 2022||Fixed Interest Rate for Direct Loans First Disbursed on or After July 1, 2022, and Before July 1, 2023|
|Direct subsidized loans and direct unsubsidized loans||Undergraduate||3.73%||4.99%|
|Direct unsubsidized loans||Graduate or professional||5.28%||6.54%|
|Direct PLUS loans||Parents and graduate or professional students||6.28%||7.54%|
Source: U.S. Department of Education, Federal Student Aid
Rising Rates on Variable Rate Loans
While borrowers with existing federal student loans benefit from fixed interest rates that won't change based on market conditions, borrowers with private student loans may not be so lucky. The fact is, that many private student loans come with variable rates that can and often do go up over time.
Unfortunately, rates going up by as little as 0.5% or 1% can cause monthly payments and total interest charges to rise substantially. As an example, let's say you are beginning repayment on $20,000 in student loans with a current interest rate of 5%. In that case, the monthly payment on a 10-year repayment plan would work out to $212.13.
When you play around with a loan calculator, however, you'll see that boosting the rate to 5.5% increases the monthly payment to $217.05, whereas increasing the rate to 6% makes the monthly payment jump to $222.04. With each of these payment amounts, the total interest paid over 10 years works out to $5,455.12, $6,046.31, and $6,644.92, respectively.
In other words, you'll pay almost $600 more in total interest charges if your rate increases from 5% to 5.5% or more than $1,189 extra in interest if your rate jumps from 5% to 6%. Of course, the impact only goes up from here if you owe more than $20,000 in student loans or your interest rate climbs higher than that.
Less Disposable Income Means Problems Making Payments
Inflation means that nearly everything you buy costs more and this inevitably leads to having less disposable income in your pocket. Even if your monthly student loan payment is the same as it was before, you may still have less extra cash to make the required monthly payments as time goes by.
With that in mind, it's a good idea to take stock of how much you'll owe on federal student loans come Jan. 1, 2023. Doing so can help you decide if you can still afford your monthly payment. If you're worried you won't be able to, now's the time to look into other student loan repayment options, such as income-driven repayment plans.
Increased Wages Could Impact Payments
If you're lucky enough to get a raise due to inflation, you should also know that the monthly payment on your federal student loans could rise as a result. This mostly applies to borrowers who participate in income-driven repayment plans that base their monthly payments on how much they earn.
As an example, the Pay As You Earn (PAYE) repayment plan requires participants to pay 10% of their discretionary income toward their loans as long as it's not more than they would pay on a standard, 10-year repayment plan, according to Federal Student Aid. Also, note that the term discretionary income is used to describe "the difference between your annual income and 150% of the poverty guideline for your family size and state of residence."
If you do get a big raise, but the poverty guidelines in your state of residence stay the same, there's a good chance the monthly payment on this plan and other income-driven plans could go up. If you're curious about what that change could look like, this loan simulator from the U.S. Department of Education can give you an idea.
Will Rising Interest Rates Affect Student Loans?
Rising interest rates mean that the fixed rates on federal student loans are going up for future borrowers. Higher rates also impact student loans with variable interest rates, which feature rates that fluctuate based on market conditions.
Should I Refinance My Student Loans?
The decision to refinance your student loans is a personal one, but you should know that you'll give up federal benefits if you refinance federal student loans with a private lender. For example, you'll give up the chance to apply for deferment or forbearance, in addition to your ability to participate in income-driven repayment plans.
Will Student Loan Debt Be Canceled?
Yes, a certain amount of student loans will be cancelled for qualified individuals. The Biden administration announced that it would forgive a portion of federal student loans based on income levels. For individuals making less than $125,000 ($250,000 for couples) and who had a Pell Grant at school, a total of $20,000 in loans will be forgiven. For those who did not have a Pell Grant, $10,000 will be forgiven.
The Bottom Line
Inflation has a major impact on nearly every aspect of our lives and that's especially true for people with student loans and other types of debt. If you're worried inflation may impact your ability to repay your student loans, you should reach out to your loan servicer and consider switching repayment plans before payments resume.
Federal Student Aid. "COVID-19 Emergency Relief and Federal Student Aid."
U.S. Bureau of Labor Statistics. "Consumer Price Index July 2022"
Federal Reserve System. "Open Market Operations."
Federal Reserve System. "Federal Reserve Issues FOMC Statement: July 27, 2022."
Federal Student Aid. "Interest Rates and Fees for Federal Student Loans."
Consumer Financial Protection Bureau. "What Are the Interest Rates on My Student Loans?"
Federal Student Aid. "Pay As You Earn (PAYE) Plan."
Federal Student Aid. "Discretionary Income."
Federal Student Aid. "Should I Refinance My Federal Student Loans into a Private Loan?"