Interest Rates – Now and Future

Variable vs Fixed

Not too many years ago interest rates on Stafford loans and other programs changed from fixed rate to variable rate. Then, as of July 1, 2006 they changed back to fixed again.

But they can change again. What the Government does, it can undo. Also, because lenders have some flexibility, even official rates can be altered in subtle ways. Many lenders, for example, charge the Federally established origination fee of 3% and the default insurance rate of 1%. Others are willing to absorb those costs to get your business. As a rough rule of thumb, every 3% in fees is equivalent to approximately 1% in interest rate.

Rates and Interest Amounts

Though the interest rate changes can be modest, PLUS loans increased from 6.1% to 8.5%, for example. On, say, even as low as $16,000 borrowed, a 2.4% rate difference equals (approximately) a $400 difference in interest charges the first year alone.

For exact amounts, per month, run sample scenarios using a loan calculator, such as that at http://www.bankrate.com/brm/mortgage-calculator.asp

The Future

There are no guarantees. The rates can change, since they’re similar to variable rate home loans, even after the loans are funded. Predicting interest rates, both near term and long term, is a task that challenges even the finest financial experts. If it were otherwise, the bond market would be a pretty dull affair (which it’s not). So, the best the average student or parent can do is to look to what those experts are predicting.

Follow The Leaders

Among the easier ways to follow those predictions is to look at various interest-bearing financial instruments, such as T-Bills or long-term corporate bonds. By examining those numbers, potential borrowers can get the best available guess about where interest rates are headed. That information is easily gained from any finance website, such as Yahoo Finance or some other personal favorite.

Looking at the 30-year Treasury bill, for example, shows two things: what the government is offering to sell debt for projected out over 30 years, and what the buyers of that debt are willing to pay. As that rate varies, most other long-term rates, such as student loan rates, will vary similarly (though not always exactly).

Corporate Bonds

The same can be said of certain corporate bonds. Ford Motor Co., for example, has been in financial difficulty for the past few years and that fact is reflected in their bond rates and ratings. Their quality ratings have dipped to near junk bond level, and the rates are significantly higher than average. Many are over 10% coupon rate, a full 5% above money market rates. For most of the large, older, ‘blue chip’ corporations, their bond rates on long bonds (over 10 years) are a good indicator.

Keeping Up

As rates rise, it becomes more difficult for borrowers to pay back the loan. Not only does that cost students and parents more money, but it can make it more difficult to qualify since the higher numbers are factored into lending decisions. Stafford and many others are need-based so it’s not a factor there, but interest rates of one program tend to influence others which may be credit history based.

In a volatile market, the best strategy for many students and parents is to obtain a private loan at a fixed rate. The best loans cost Prime Rate – 1%. That’s a very good deal, but borrowers will need very good credit to qualify.

There’s no ideal solution to financing the high cost of, and the high cost of borrowing for, education today. But, as with any cost, shopping around to find out all the available options is the best bet for the long-term.