Everyone has been reeling from economic changes caused by the COVID-19 pandemic. Any bit of good news helps and here it is: Federal Direct Student Loan interest rates will likely be almost 2% lower for loans taken in the 2020-21 academic year vs. this past year.
Why? Unemployment claims jumped up to 6.6 million for the week ending in April 4, 2020. That means that total unemployment claims in the last three weeks have reached 16 million according to the US Department of Labor. When coupled with the Federal Reserve indicating the likelihood of a recession, the rates for the 10-year Treasury note plummeted even further than before to a low of .73%.
Why do you care? Well, the Congressional Budget Office (CBO) uses the 10-year Treasury note to set the next year’s Federal Direct Loan interest rates. Next year’s rate will be established based on the rate set in May and it's highly unlikely that it will increase much in the next few weeks.
The May US Treasury Note auction rate was at .70%. Starting July 1, 2020, the ACTUAL interest rates will be:
Federal Direct Student Loans for undergraduates: 2.75%
Federal Direct Student Loans for graduates: 4.30%
Federal Direct Parent PLUS loans: 5.30%
How are Federal Direct Loan Interest Rates Calculated?
The CBO has a formula for each type of Federal Direct Loan to fix the rate while in school and in repayment. Federal Direct Student Loans for undergraduates use the May sale of the 10-year Treasury rate plus 2.05%, capped at 8.25% whereas the Federal Direct Student Loans for graduates take the 10-year rate plus 3.60%, capped at 9.50%. Federal Direct Parent PLUS loans add 4.60% to the 10-year Treasury and are capped at 10.50%.
What if the Rates Were Set Today?
If the Federal Direct Loans used the April 9, 2020 sale of the 10-year Treasury rate, the rates would be the lowest fixed interest rates in decades. Student borrowers would have the lowest interest rates. The 2020-21 Federal Direct Student Loans for undergraduates would be 2.78%, down from 4.53%, and the 2020-21 Federal Direct Student Loans for graduates would be down by 1.75% to 4.33% (down from 6.08%). Parent borrowers will benefit too. The 2020-21 Federal Direct Parent PLUS Loans would be 5.33% versus this year’s rate of 7.08%.
With this level of interest rate reductions, the federal loan borrowers will have significant savings on next year’s loan based on Quatromoney’s estimates. With the average 2018-19 Federal Direct Parent PLUS Loan at $17,220 (according to the College Board's Trends in Student Aid, parent borrowers will save over $3,300 over the life of the loan with the estimated interest rate. Student borrowers will have huge savings too.
With the average 2018-19 unsubsidized Federal Direct Student Loan at $7,488 (according to the College Board's Trends in Student Aid, Quatromoney estimates that student borrowers will save over $1,200 over the life of the loan with the estimated interest rate next year.
Don't Forget the Fees
Federal Direct Loans have loan fees that are deducted from each disbursement. This means that you actually receive less funds than you actually borrowed. Because of sequestration, an automatic deficit reduction cutting mechanism imposed under the Budget Control Act of 2011, these loan fees are set at the start of the new federal fiscal year which started on October 1st. Currently, Federal Direct Student Loans have a 1.059% loan fee deducted from each disbursement whereas Federal Direct Parent PLUS Loans have a 4.236% loan fee.
This means if you borrowed a $5,000 Federal Direct Student Loan right now, you would net $4,947.05 after loan fees.
However, if you borrowed the same amount in the Federal Direct Parent PLUS Loan, then you would net only $4,788.20. It’s hard to tell what the Office of Management and Budget (OMB) will set these rates for 2020-21.
Colleen MacDonald Krumwiede is a financial aid and paying for college expert with over a decade of financial aid experience at Stanford GSB, Caltech, and Pomona College and another decade at educational finance and technology companies servicing higher education. She guides go-to-market strategy and product development at Quatromoney to transform the way families afford college.