Young people looking to weather the economic downturn in the haven of higher education will have a nice savings surprise if they need to borrow money to cover their education.
The coronavirus has led to interest rates close to zero:
In March, as the effects of the coronavirus sent shockwaves through the U.S. economy, the Federal Reserve lower benchmark interest rates by a full percentage point, which places them in the range of 0 to 0.25 percent. The rate cut was part of the central bank‘s emergency lending programs designed to mitigate economic deterioration and maintain credit.
The Fed’s rate cuts boosted performance on the benchmark 10-year Treasury bill to decline as well. In March, the yield dipped to a low of 0.635% overnight before rebounding slightly. As of June 5, the yield was 0.91%. Why is the 10-year Treasury rate so important?
Federal student loan rates are tied to the 10-year Treasury yield
Federal student loan rates are set annually by Congress and are linked to the yield on 10-year treasury bills. As StudentLoanHero.com points out, “Student loan rates are set in the spring for each new school year. They are effective from July 1 to June 30 of the following year. To make sure interest rates don’t rise too high, Congress also includes rate caps for each type of student loan.
The specific formula differs depending on the type of loan:
- Direct unsubsidized loans for undergraduates: 10-year cash flow + 2.05%, capped at 8.25%
- Non-subsidized direct loans for graduates: 10-year cash flow + 3.60%, capped at 9.50%
- Direct PLUS loans: 10-year cash flow + 4.60%, capped at 10.50%
The rate cut by the Fed and the resulting drop in the 10-year Treasury yield therefore translates into lower interest rates and lower borrowing costs for incoming students.
Here are the interest rates for new loans:
The new interest rates will take effect July 1, 2020, but are based on the 10-year Treasury yield on May 12, 2020. For graduate students, the interest rate on unsubsidized direct loans will decrease from 6.079% to 4.3% and the interest rate on Direct PLUS loans will drop from 7.079% to 5.3%. This represents a drop of almost 40 percent in rates.
Graduate student debt levels are high:
How much graduate students will save depends on how much they borrow and what repayment plan they choose (it also depends on whether the rates stay the same for years to come or change).
Here is the average amount borrowed by students in different graduate fields:
- Faculty of Medicine: $ 195,000 is the median medical school debt for 2018 graduates with medical school loans, excluding pre-medical school loans (private medical school graduates in debt had a median student loan balance of $ 210,000)
- Faculty of Law: $ 115,481 borrowed on average just to pay for law studies (loans from private law schools average $ 130,900)
- Business school: $ 100,000; a investigation out of 10,000 MBA graduates from the Class of 2018, per Bloomberg Businessweek, found that almost borrowed at least $ 100,000 to fund a business school.
New loan rates could save thousands of graduate students:
Lower student loan rates will mean lower payments for graduate students after graduation.
- Scenario 1 – The doctor saves more than $ 21,000: An aspiring doctor entering medical school this fall who ends up with a median debt level of $ 195,000 and uses the standard 10-year repayment plan. Assuming that this student had reached the overall unsubsidized loan limits and funded $ 195,000 with Direct Plus loans, she would save over $ 21,000 with the lower interest rates.
- Scenario 2 – The doctor saves more than $ 18,000: If the same aspiring doctor had no undergraduate debt, maxed out direct unsubsidized graduate loans (limit $ 40,500 per year, total $ 162,000 over four years), and used Direct Plus loans for the remaining $ 33,000, she would save over $ 18,000 due to lower interest. rates.
- Scenario 3 – The lawyer saves more than $ 12,000: If an aspiring lawyer funds $ 115,000 of law school using Direct Plus loans, she would save over $ 12,000 due to the lower interest rates.
- Scenario 4 – A businesswoman saves more than $ 10,000: An MBA graduate who funds $ 100,000 with Direct Plus loans would save over $ 10,000 in light of the new rates.
In general, you can expect to save about $ 1,000 for every $ 10,000 in loans taken at the new rates, assuming a standard 10-year repayment plan. Lower rates will not result in significantly lower monthly payments, which will only decrease by a perfect 8%. For example, the aspiring physician in Scenario 1 would have received monthly payments of $ 2,272 below the old rate of 7.079%; with the new 5.3% rates, her monthly payment would be $ 175 lower, or $ 2,097. However, these amounts add up over the repayment period.