Each year, hundreds of thousands of college students take out student loans to help pay for their education. When they take these loans out, they aren’t necessarily worried about interest rates; they just need the money. They will worry about paying back the loans when the time comes. When that time comes, they are often shocked by how much they actually owe on the loan.
Interest rates can significantly increase the total cost of your student loan. You may have borrowed only $10,000 to help finance your undergraduate degree, but you will not just be paying back the $10,000. You are responsible for interest, too. Interest can add thousands of dollars to your overall bill. In fact, some students have found that their interest payments are more than the original amount of the loan.
Types of Interest Rates
Student loans will carry either a fixed or variable interest rate. Today, federal student loans carry a fixed interest rate. A fixed interest rate will never change during the life of the loan. If your loan carries an interest rate of 3.5% at the signing, your interest will remain at 3.5% for the next 10 years. If your federal student loan was issued before July 1, 2006, the loan will carry a variable interest rate.
Most private student loans issued by banks carry a variable interest rate. Variable interest rates change throughout the life of the loan. The rates are determined by economic market factors like inflation, deflation, and Federal Reserve decisions. When economic conditions are strong, banks charge more interest. When the economy falters, interest rates will often begin to come down.
Banks are taking a risk by loaning you money for your education. They hope you won’t default on the loan, but cannot be sure, so, they compensate for that risk by charging variable rates. Let’s look at a quick example. Initially, your loan had a variable interest rate of 4.75%, but two years later the interest rate jumped to 9.75%. Your monthly interest payment just doubled! You can see why this type of interest can cause significant financial problems for people.
How Consolidating Can Lower Your Rate
Student loan consolidation can help you lower your interest rate. By consolidating all your private student loans, you will receive one monthly bill and one fixed interest rate. Consolidation companies have their own processes for developing this new rate. Often, it is a blend or average of your current rates. Consolidating your loans will usually make this interest rate fixed instead of variable, which can help reduce your overall payments.
When you initially applied for your student loan, your credit rating was probably not so great. You had not made any large purchases, so your credit history was not yet established. High interest rates may have been charged to make sure the bank covered their risk. Now, after a few years, you have established a credit history. This credit history can help you during the consolidation process. Borrowers will often be rewarded for their good history with reduced interest rates.
Should You Consider It
When people hear there is an opportunity to lower their student loan interest rates, they often jump at the chance. However, there are a few things you need to consider before starting the process. If you have federal student loans issued after July 1, 2006, your interest rates are already fixed, so, your interest rates will not be lowered.
Private student loan borrowers need to analyze all of the different private loans they hold. Calculate the outstanding interest payments for each of those loans, and make sure that consolidating makes sense. People sometimes find that their largest loan has a lower interest rate than their smaller ones. They may actually end up paying more in interest if they consolidate all their loans. If you decide that consolidating is right for you, come up with a few interest calculations on your own. You may decide to present these calculations to your loan officer and see if there is any room for negotiation.