Federal Student Loan Interest Rates Just Went Up – How Much Will This Cost You?

July 14, 2014

The good news is that student loan interest rates did not rise quite as high as the Consumer Financial Protection Bureau predicted and that we wrote about in May. The bad news is they still rose significantly over what the rates were. Undergraduate loans were at 3.86%, graduate loans were 5.41% and PLUS loans were at 6.41%. They have risen to 4.66% for undergrad loans, 6.21% for graduate and 7.21% for PLUS.

Interest rates on the rise

Student loan interest rates have risen – how will this impact you?
Image source: Flickr Creative Commons User Chris Butterworth

This represents an increase of 30%, 15% and 12.5% respectively. But what does this mean for borrowers? Let’s crunch some numbers. If you take out a $7,500 loan at the old rate of 3.86%, your total interest on a 10 year loan would be $1,550. At the new interest rate of 4.66%, your interest rate increases to $1,900. On a 10 year loan, this is a large increase at $350, but it’s not outrageous.

The rate hike would be less of a big deal if all (or even most) borrowers could pay off their debt within the 10 years, but this isn’t the case. According to a report by the Federal Reserve Bank, many graduates are still paying off their loans 15-20 years after borrowing. Let’s look at the same loan of $7,500 and the interest differential if you have to take two decades to pay.

Borrowing $7,500 at 3.86% for 20 years will cost you $2,760 in interest. Up that to 4.66% and your interest jumps to $3,770. And if you opt for Income Based Repayment or Pay As You Earn then take the balance forgiveness after 20-25 years of repayment, you’ll be hit with a much larger tax bill based on the interest difference.

Under both IBR and PAYE, if the payments are not enough to cover the monthly interest, the interest will capitalize and the balances will continue to rise rather than diminishing. And although the remaining balance can be forgiven, the forgiven amount will be taxable. The greater your interest amount, the higher the forgiven balance will be and the greater the resulting tax burden will be.

And this is just the impact on one modest-sized loan. Students just beginning to borrow will face higher balances at the higher rates. At the average debt of around $30,000 for most grads, the expired 3.86% rate would run a little more than $6,200 in interest over a decade. Up that to the new rates of 4.66% under a 10 year plan, and you’re up to $7,600.

The bottom line is, the higher these interest rates climb, the worse it is for borrowers. This rate hike is bad news, but worse news is the principal on student loans keeps rising because colleges continue to increase both tuition and fees which makes financing an education so much harder for students. We can only hope that, at some point, lower rate refinance legislation will make its way through Congress and that colleges will tighten their budgets and cut tuition because it’s the right thing to do.

Be sure to sign up for Tution.io’s free student loan tool to keep track of all your loans, both federal and private, in one easy-to-understand dashboard. Read our blog often and check out our Student Loan Help Center for How To guides on a variety of student loan topics and a ton of other great info.