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Predicting Future Student Loan Interest Rates

Predicting future interest rates can be challenging, but there are ways to make a reasonable prediction. Interest rates on new federal student loans will likely increase by about two percentage points (2%) starting on July 1, 2023. 

The interest rates for the next year are set based on the high yield of the last 10-year Treasury Note auction in May, plus margins based on loan type.

With this information in hand, we can make some reasonable predictions about future student loan interest rates.

Table of Contents

How To Predict Future Student Loan Interest Rates
Current Student Loan Interest Rates
Basing A Prediction On Current Rates
Adjusting The Prediction For Changes In Interest Rates
Consequences Of The Change In Interest Rates

How To Predict Future Student Loan Interest Rates

This goal reminds me of a joke: What’s the difference between a meteorologist and an economist? The meteorologist doesn’t claim to be able to control the weather.

But, predicting interest rates and predicting the weather do have one thing in common.

If you want to predict tomorrow’s weather, look out the window today. 

So, to predict interest rates, compare current economic conditions with how they were when the interest rates were last set.

Current Student Loan Interest Rates

Interest rates for federal student loans in 2022-23 are currently 4.993% for undergraduate students, 6.543% for graduate students and 7.543% for PLUS loans.

These interest rates are based on the high yield of the last 10-year Treasury Note auction in May, plus margins of 2.05%, 3.6% and 4.6%, respectively, with caps of 8.25%, 9.5% and 10.5%.

There are monthly auctions of the 10-year Treasury Note, so these auctions can provide insights concerning the interest rate trajectory. 

Basing A Prediction On Current Rates

If we were to base the new student loan interest rates on the 10-year Treasury Note auction high yield of 3.625% based on the December 12, 2022 auction, they would be 5.675%, 7.225% and 8.225%, respectively. 

Basing interest rates on the January 11, 2023 auction’s high yield of 3.575%, which was 0.05% lower, would yield student loan interest rates of 5.625%, 7.165% and 8.175%. 

Adjusting The Prediction For Changes In Interest Rates

However, the current rates were based on the May 11, 2022 auction rate of 2.943%, which was 1.425% higher than the December 8, 2021 auction rate of 1.518%. This was after the Federal Reserve Board increased interest rates by a total of 0.75%. 

The Federal Reserve Board increased interest rates by 0.25% on February 1, 2023 and said that it still sees a need for “ongoing increases.” This suggests that there will be a further 0.25% increase on March 22, 2023 and another on May 2, 2023. So, the rate of rate increases will be slowing. 

Still, that suggests that the 10-year Treasury Note auction in May 2023 will have a high yield of 1.425% + 3.625%, or 5.05%, which will yield new interest rates of 7.10%, 8.65% and 9.65%, if we base it on the December 12, 2022 auction. If we base it on the January 11, 2023 auction, this suggests that the May 2023 auction will have a high yield of 1.220% + 3.575%, or 4.795%, which will yield new interest rates of 6.845%, 8.395% and 9.395%. 

Of course, the Federal Reserve Board could increase interest rates further, but this is the most likely scenario. Also, increases in the high yield on the 10-year Treasury Note auction aren’t necessarily well aligned with increases in the Federal Funds Rate. 

But, a good educated guess is that interest rates for 2023-24, which go into effect on July 1, 2023, will be about 7%, 8.5% and 9.5%, respectively. That’s an increase of about two percentage points. 

Consequences Of The Change In Interest Rates

This will be the third year in a row with interest rate increases of more than a full percentage point. Interest rates for undergraduate students increased from 2.75% in 2020-21 to 3.734% in 2021-22 and 4.993% in 2022-23.

A two percentage point increase in interest rates, from about 5% to about 7%, will increase monthly student loan payments by almost 10% on a 10-year repayment term. 

Editor: Robert Farrington

The post Predicting Future Student Loan Interest Rates appeared first on The College Investor.

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