Student Loan Interest Rates Will Increase Slightly This Year

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By Mark Kantrowitz

March 18, 2021

Interest rates on federal education loans are likely to increase slightly this year, while interest rates on private student loans and private refinance will probably remain unchanged.

How Does Congress Set Interest Rates on Federal Student Loans?

Interest rates on federal student loans change each July 1, based on the high yield of the last 10-year Treasury Note auction in May, which is usually the only 10-year Treasury Note auction. Each year’s new interest rates are fixed for the life of the loan.

For example, the interest rates in 2020-2021 are fixed rates based on the May 12, 2020 auction, which had a high yield of 0.70%. This yielded interest rates of:

  • 2.75% on the undergraduate Federal Direct Stafford Loan
  • 4.30% on the graduate Federal Direct Stafford Loan
  • 5.30% on the Federal Direct PLUS Loan.

The 10-year Treasury Note auction will be on May 12, 2021.

How to Predict the New Interest Rates

One can use the high yield on auctions in earlier months to predict the high yield in the May auction.

The high yield on the March 10, 2021 auction was 1.523%. That’s 0.823% percentage points higher than the high yield from May 12, 2020, pointing at an increase in interest rates on federal education loans.

The high yield is up from 1.155% in February 2020 and 1.164% in January 2020. The increase is due to investors shifting from bonds to stocks, in part because of passage of the American Rescue Plan Act of 2021 (ARPA) and optimism about the end of the pandemic, as well as the supply of bonds exceeding the demand. Decreased demand for bonds drives down the prices on bonds, which increases the yields.

Historically, the 10-year Treasury Note yields drop by about 18.5 bp from March to May.

That suggests that the new interest rates for 2021-22 will be about:

  • 3.5% for undergraduate loans
  • 5.0% for graduate loans
  • 6.0% for parent loans

Nevertheless, the bond market has been more volatile this year, so interest rate predictions may be less certain. The increase in the high yield may be temporary or more muted.

Interest Rates on Private Student Loans

Interest rates on private student loans may remain low. The current lowest interest rates on new private student loans for undergraduate students are 3.34% fixed and 1.04% variable, which is down from 4.24% fixed and 1.49% variable in August 2020.

The best interest rates on private refi are 2.59% fixed and 1.61% variable. These interest rates have not varied by much over the last six months.

Interest rates on private student loans are generally pegged to the 1-month or 3-month LIBOR index, which is influenced by the Federal Funds Rate. The Federal Reserve Board has pledged to keep interest rates low through 2023 to facilitate the economic recovery after the end of the pandemic, so the Federal Funds Rate is not expected to change.

Should Your Refinance Your Student Loans?

There’s no rush to refinance federal student loans.

Federal student loans held by the U.S. Department of Education are eligible for an automatic payment pause and interest waiver through September 30, 2021. That’s the equivalent of a 0% interest rate, which private student loans can’t beat.

When the payment pause and interest waiver expires, borrowers may wish to refinance federal student loans from several years ago, when interest rates were much higher. Refinancing federal loans into a private student loan loses the superior benefits of federal loans, such as longer deferments and forbearances, income-driven repayment plans and the possibility of loan forgiveness.

President Biden has reaffirmed his campaign promise to forgive $10,000 in student loan debt per borrower. The government may limit this benefit to federal student loans, just like the payment pause and interest waiver. It remains to be seen when and if Congress will act to pass a loan forgiveness proposal. Early fall seems likely, before the expiration of the payment pause and interest waiver. The American Rescue Plan Act of 2021 provides tax-free status to student loan forgiveness through the end of 2025.

Private student loans aren’t eligible for the payment pause and interest waiver, so there’s no reason why borrowers shouldn’t refinance their private student loans, especially if they can qualify for a much lower interest rate.

A good place to start:

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