You will never find interest rates like student loan interest rates. Thanks to strong borrowing terms, a surplus of capital, and laws that favor banks, student loan interest rates are lower than most every other type of loan. Plus, there is plenty of competition, which helps keep a lid on interest rates from bank to bank.
Federal Student Loan Interest Rates
Federal student loan rates are typically higher than most, set by Congress and extended to everyone after a student files the Free Application For Federal Student Aid, or FASFA. The rates offered to borrowers vary from loan to loan:
Subsidized loans – These loans have the lowest interest rate, as some of the interest is paid by Congress. Expect this rate to equal roughly that of a variable rate loan from a private lender. Of course, subsidized loans have a great benefit: they’re fixed for the life of the loan.
Unsubsidized loans – Unsubsidized Stafford loans have higher rates, as the full interest rate is paid by the borrower, currently 6.2% per year, fixed for the life of the loan. Unsubsidized loans are the most common, as many people do not qualify for subsidized loans in an amount equal to their financial need.
Parent loans – Parent Plus loans are the highest interest rate loans, offered to parents of a new college student. There is an approval process for Parent Plus loans, but the interest rate is set at a fixed 8.9% (numbers as of 2011). A parent can borrow practically any amount equal to the amount of financial need.
Private Student Loan Rates
Unlike the federal government, private student lenders can be pickier about who they choose to lend money. As a result, private student loan lenders will reject students with poor credit, or high debt loads, and thus have a much lower default rate. In picking only the “cream of the crop,” and having different rates for different people, a private lender is capable of passing on these lower rates to high quality borrowers.
There are two broader types of private student loans:
Fixed – Fixed interest rate loans have a higher immediate rate than adjustable rate loans, however, the rate of interest is fixed, and will not change higher or lower.
Adjustable – Adjustable rates can be great for people who want the lowest rate possible, but know that the rate can rise when interest rates rise, making you pay more for your financed education.
Take into consideration that all loans are priced on a prime basis, meaning that the lender borrows money from other banks, and then loans the money to customers.
There are two different rates a private lender might use:
1. LIBOR – The London InterBank Offered Rate is the rate of interest which banks charge other banks. The best student loans will have an interest rate equal to the LIBOR rate plus 2%. So, if the 1 year LIBOR is 3%, then the student loans for good credit quality borrowers will be priced at 5%.
2. Prime – The rate for prime borrowers, this rate can differ depending on the application. For student loans, expect to find rates that are equal to the prime rate, or prime minus .5%.
You ensure that you’re making an apples to apples comparison in evaluating student loan interest rates, always ask for their premium over prime or LIBOR. That way, you can know which bank is cheaper than the other based on a very simple calculation.
Lower Your Student Loan Rates
There are a few things you can do to make sure that you get the best rates on your student loans. These are:
1. Get a cosigner – Two is better than one, and banks like to see that your parents, other relatives, or friends are willing to put their rubber stamp on your ability to repay a debt.
2. Schedule payments – Allowing the lender to deduct automatically your payment each month from a checking account will save you .25% or more off the stated interest rate. On a $10,000 balance, that works out to $25 a year, but the compounding is what really saves you!
3. Borrow small – The lower your request for money, the better the rate. When banks see that you’re borrowing only a very small amount each semester or school year, they know that there is a very small chance that you won’t pay. Plus, it shows financial responsibility in not financing things unrelated to school.