Why Are Interest Rates On Student Loans So High?

Why Are Interest Rates On Student Loans So High?

6 min read


Student loans have become the bane of our existence. Even though we’re living in the greatest time ever, student loan debt is at record levels. And according to some experts, interest rates could be higher than they were during the Great Recession. In fact, the average rate on federal student loans increased from 6.8% to 8.5%. That’s bad news if you’re hoping to buy a home or start a business in 2018.

What makes matters worse is that many people just don’t understand how student loans work. “Everyone thinks that these things are free money,” says Aaron Ochoa-Bracamonte, senior director of strategic partnerships at Muhlenberg College. “But the reality is that they’re not.”

Here’s what students need to know about student loans, including the difference between private vs. federal loans, and how to pay back a federal loan.

Private vs. Federal Loans

A lot of people think that private student loans are a good option because they offer lower interest rates. But this isn’t always true. Private student loans carry their own set of risks. You may get stuck paying high interest rates if you choose a lender that’s too risky, or you might end up having to pay much higher interest rates than you anticipated. If you decide to take out a private loan, make sure to shop around for the best deal.

The biggest advantage of federal student loans, however, is that they aren’t tied to your credit score. “It doesn’t matter whether you have perfect credit, no credit, bankruptcy, foreclosures, late payments – whatever,” explains Ochobracamonte. “You still qualify.”

Federal loans also require a co-signer with good credit who agrees to help you repay the amount owed. If you default, this person (usually a parent) will be responsible for repaying any unpaid loans along with yours. As for private lenders, you won’t have that protection.

Getting Repaid

Most students assume that after graduation, they’ll find jobs with decent salaries right away. But this isn‘t necessarily the case. According to CareerBuilder, almost 50% of recent college graduates said they had trouble finding a job in May 2016. A lack of skills and experience can mean that even those with strong resumes struggle to land a job.

As a result, students often have to take low-paying jobs while they go to school. However, federal loans allow them to defer payment until they earn a certain amount each year. At the same time, borrowers can avoid interest charges.

If you do manage to land a full-time position, you will likely be asked to begin making payments immediately after graduating. Most private student loans don’t offer the same flexibility.

Even without a steady income, borrowers can use public service jobs, internships, and volunteer work to offset student loan bills.

How Debt Affects Your Credit Score

When you borrow money, the bank or financial institution you borrowed from reports that information to the three major credit reporting companies: Equifax, Experian, and TransUnion. This data — called “credit history” — is then used to calculate your credit score.

Why Are Interest Rates On Student Loans So High?

Student loan interest rates have been steadily rising over the past few years, making it harder and harder for students to afford college. In 2016, private student loans carried an average annual rate of 6.41%. By 2019, the average was up to 8.22% — nearly double what it was just six years earlier. What’s even worse? According to the U.S. Department of Education, more than 1 million students defaulted on their federal student loans in 2018 alone.

Why Are Interest Rates On Student Loans So High?

Because Congress won’t let them go down!

Student loan interest rates have been set at 8.25% since July 1st 2010. In August 2015, they were raised slightly to 8.45%, and then again in September 2016 to 9.21%. However, interest rates cannot legally exceed 10.5%. If Congress doesn’t approve legislation lowering student loan rates before January 1st 2017, they could potentially increase even further.

When Congress passed the Higher Education Act in 1965, the rate was fixed at 6.8%. Then, in 1972, the rate increased to 7.9%. Ten years later, it jumped to 11.1%. Finally, in 1988, it hit its current level of 12.5%.

Students who borrow money for college face some pretty high costs. For example, in 2012, private-sector borrowers paid an average of $2600 in interest per year while federal government loans cost nearly $4000. That’s over $10,000 over four years. And the total amount borrowed rose significantly as well.

Why haven’t we lowered these rates? Well, first of all, not much money comes back to taxpayers. Second, it would hurt banks’ profits. Third, colleges get millions of dollars each year in donations from alumni whose kids owe a lot of money. I guess we could make the argument that students are getting a good deal, but if you look at the long run, they aren’t.

To sum everything up, we’ve got a situation where interest rates keep going up on student loans. But, hey, at least the United States finally has its own currency again.

Why Are Interest Rates On Student Loans So High?

You’re paying interest on what was essentially just a loan taken out by the government.

If you borrowed $10k at 1% annualized compounded interest… then you’d have $11k after 12 months, $12k after 24 months, etc. But since that’s only happening once, the average return over the lifetime of the loan would be 0%.

That means that if you were making 6%, or a little bit less than that, you’d never make any money off your student loans.

Even though you might not be able to pay them back right away, eventually they’ll get paid off.

And even after repaying the principal, you’ll still owe interest until those balances are completely gone.

It’s really not worth taking a loan out from the government to go to school, especially considering how long it takes you to repay it. Plus, if you do end up getting a job that pays well enough to cover both your schooling and your debts, you’ll probably end up paying taxes on those earnings anyway.

If you don’t want to take on debt, then study abroad instead.

There’s no real reason to borrow money from the bank to finance college. If you need to borrow money to help pay for school, instead look into scholarships and grants.

If you already have some savings set aside before going to college and know you won’t be borrowing money from anyone else, then it may be worthwhile to save up some cash instead of borrowing funds.

I mean, if you do decide to pursue higher education, then you should definitely consider it. Just be sure to get yourself into good financial shape first.

If you feel like you absolutely have to borrow money, then make sure you understand what you’re signing up for.

There are many different types of federal student loans that you can choose between, including subsidized, unsubsidized, and direct. Each type offers its own advantages and disadvantages.

In order to determine whether you qualify for an Unsubsidized Loan, you need to meet certain requirements. To learn more about these criteria, check out the following links:

Why Are Interest Rates On Student Loans So High?

Interest rates on student loans have been rising at about 8% annually since 2009. While this may sound like a lot, it’s not really that high. If we look back to history, interest rates were much higher than today. In fact, interest rates topped out to nearly 20% in 1980. However, after a long period of time, it was decided that these interest rates were simply unsustainable, and the government started lowering them. There was some concern that lower interest rates would cause borrowers to borrow money before they paid off their student loan debt, causing problems down the line. This led to the government implementing programs like Income Based Repayment (IBR), where payments are based on income rather than paying the full amount. Today, interest rates are set at 1%, meaning students who borrow $17,000 a year will pay around $200 per month instead of $360. Of course, if you take advantage of IBR, you could save more than half of what you currently owe.

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