How Inflation Affects Student Borrowers


Many borrowers with student loans haven’t made a payment for over two years, and we certainly can’t blame them. After all, the United States Department of Education implemented several relief measures for the COVID-19 pandemic in March 2020, including suspending all payments on federal student loans and fixing student loan rates. interest at 0%.

This initial adjournment period was only supposed to last several months, but it has been extended six times since those early days. At this time, the emergency measures are set to expire on August 31, 2022. This means borrowers with federal student loans will have to pick up where they left off with their debt and payments will occur on September 1, 2022. In both cases, a lot happened with the economy over the past two years. One of the biggest changes has taken the form of inflation, which is currently rising at a rapid rate.

The Consumer Price Index (CPI), which is used to measure the price of various goods and services over time, rose 8.3% year-on-year (YOY) in April 2022 This is a slight drop from the annual inflation (8.5%) recorded from March 2021 to March 2022, but it is still a troubling trend. With that in mind, it’s perfectly reasonable to ask how inflation might affect student loans in general. Read on to find out why inflation matters when it comes to student debt, where issues can arise, and what you can do about it if they do.

Key points to remember

  • In March 2020, the US Department of Education announced an emergency deferral of eligible federal student loans due to the pandemic. This emergency measure included suspended payments on eligible federal student loans as well as a fixed interest rate of 0%.
  • The deferral period is currently set to expire on August 31, 2022, although the emergency measure can always be extended again before that date. If it is not extended again, borrowers with federal student loans will have to make payments again after September 1, 2022.
  • Inflation has risen dramatically so far in 2022. In fact, the Consumer Price Index rose 8.3% in April 2022 from a year earlier.
  • Some borrowers prepare for the effects of inflation on their student loans, such as higher interest rates and lower disposable income to make payments.

Increase in federal student loan rates

You may have heard that the Fed voted to raise interest rates by 0.5 basis points in May 2022, and this follows another rate hike that took place in March of this year. These rate increases have been explained as a way to help combat and ultimately stifle inflation, and we can only hope the plan works.

In the meantime, rising rates are making borrowing more expensive in general, whether you have a credit card balance or take out a personal loan. Federal student loans with fixed interest rates will also feel the impact of this rate increase, although the rate hike will only affect borrowers who take out student loans in the future.

How much do federal student loan rates increase? The chart below illustrates the current fixed interest rates for several types of federal student loans compared to what students will pay next year.

Type of loan Type of borrower 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
Subsidized Direct Loans and Unsubsidized Direct Loans First cycle 3.73% 4.99%
Direct unsubsidized loans Graduate or Professional 5.28% 6.54%
Direct Loans PLUS Parents and graduate or professional students 6.28% 7.54%

Source: US Department of Education, Federal Student Aid

Increase in rates on variable rate loans

While borrowers with existing federal student loans enjoy fixed interest rates that won’t change based on market conditions, borrowers with private student loans may not be so lucky. The thing is, many private student loans come with variable rates that can and often do increase over time.

Unfortunately, a rate increase of as little as 0.5% or 1% can result in a substantial increase in monthly payments and total interest charges. As an example, let’s say you start paying off $20,000 in student loans with a current interest rate of 5%. In this case, the monthly payment on a 10-year repayment plan would be $212.13.

However, when playing with a loan calculator, you will see that increasing the rate to 5.5% increases the monthly payment to $217.05, while increasing the rate to 6% increases the monthly payment to $222.04. With each of these payment amounts, the total interest paid over 10 years is $5,455.12, $6,046.31, and $6,644.92, respectively.

In other words, you’ll pay almost $600 more in total interest costs if your rate goes from 5% to 5.5% or more than $1,189 more in interest if your rate goes from 5% to 6%. Of course, the impact only increases from here if you owe more than $20,000 in student loans or your interest rate climbs higher than that.

Less disposable income = payment problems

Inflation means that almost everything you buy costs more, which inevitably leads to having less disposable income in your pocket. Even if your monthly student loan payment is the same as before, it means you may have even less extra money to make the required monthly payments over time.

With that in mind, it’s a good idea to take stock of how much you’ll owe on federal student loans on September 1, 2022. This can help you decide if you can still afford your monthly payment. If you’re worried you can’t, now’s the time to look at other student loan repayment options, like income-driven repayment plans.

An increase in wages could impact payments

If you are lucky enough to get an increase due to inflation, also know that your monthly federal student loan payment could increase accordingly. This primarily applies to borrowers who participate in income-driven repayment plans that base your monthly payment on how much you earn.

For example, the Pay As You Earn (PAYE) repayment plan requires participants to pay 10% of their discretionary income for their loans as long as it’s no more than they would pay on a standard 10-year repayment plan. years, 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 level for your family size and state of residence.”

If you get a big raise, but the poverty guidelines in your state of residence remain the same, chances are the monthly payment for this plan and other income-oriented plans will increase. If you’re curious what this change might look like, this loan simulator from the US Department of Education can give you an idea.

Will rising interest rates affect student loans?

Rising interest rates mean that fixed rates on federal student loans go up for future borrowers. Higher rates also impact student loans with variable interest rates, which feature rates that fluctuate with market conditions.

Should I refinance my student loans?

The decision to refinance your student loans is a personal decision, but you should be aware that you will forfeit federal benefits if you refinance federal student loans with a private lender. For example, you will forfeit the ability to request a deferral or forbearance, in addition to your ability to participate in income-driven repayment plans.

Will student loan debt be forgiven?

President Biden has been clear about his intention to cancel a portion of federal student loan debt per borrower since the start of his campaign. However, no one knows for sure how much debt will be forgiven, who will qualify, or if this plan will materialize.

The essential

Inflation has a major impact on almost every aspect of our lives, and this is especially true for people with student loans and other types of debt. If you’re concerned that inflation will affect your ability to repay your student loans, you should contact your loan servicer and consider changing your repayment plan before payments resume later this year.

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