iQuanti: Inflation may seem abstract, but it has a significant impact on nearly everyone, regardless of their financial situation. While inflation typically happens year over year in the background, particularly high inflation has made the news recently, and it may be worth preparing for its impact. The truth is, inflation impacts not only the prices of consumer goods and investment tools but long-term debts such as student loans.
During inflation, the price of goods and services rises and purchasing power falls. There is a significant correlation between student loan prices and the national inflation rate, in large part because Treasury Bond interest rates are increased.
The Congressional Budget Office uses the formulas below to set the APR for federal student loans, which is renegotiated every May:
- 10-Year Treasury Rate plus 2.05 percent for direct undergraduate loans
- 10-Year Treasury Rate plus 3.6 percent for direct graduate loans
- 10-Year Treasury Rate plus 4.6 percent for direct PLUS loans
This formula remains consistent, but the 10-Year Treasury Rate varies. For loans disbursed between July 1, 2021 and July 1, 2022, the 10-Year Treasury Rate is 1.684%.
Debt and Interest Rates During Inflation
Believe it or not, some student loan borrowers celebrate inflation — and if you have a fixed interest rate on your loans, you might join them. Because many student loans have fixed interest rates with long terms of 10 to 30 years, they are not sensitive to the fluctuation in the market like variable rate loans. Borrowers who choose to refinance their student loans often have fixed-rate refinancing options available.
The value of the loans decreases as the rise in inflation devalues the dollar. Loans that were taken out before inflation are worth less when paid in the present.
While this sounds great, you only benefit if your wages keep up with inflation, as household expenses will also rise. If inflation rises more than wage rates, consumers lose purchasing power, and the ability to repay debt declines.
Can Refinancing Save Money?
If your loans are variable-rate, rather than fixed-rate, the advantage of holding debt through inflation may escape you, but it's possible to lock in a fixed rate with a refinance.
Under the right circumstances, refinancing student loans may save money and have other benefits. Refinancing may lower your interest rate, convert a variable rate loan to a fixed rate, consolidate loans for one monthly payment, or release a loan co-signer.
The interest rates for student loans in 2021 were some of the lowest ever seen. If you have the opportunity to refinance to a much lower interest rate than your current loan, it may be a great chance to grab a fixed rate.
On the flip side, you may lose benefits and protections from the original loan. Those owing federal student loans have enjoyed a long student loan interest and payment pause through COVID-19, and some may feel enticed by the debate over the potential forgiveness of some amount of federal student debt. It's important to understand the potential trade-offs before refinancing.
Reasons to refinance a student loan include:
- Qualifying for a lower interest rate
- Establishing a fixed rate rather than a variable interest rate
- Reducing the number of monthly payments
- Releasing a co-signer
The Bottom Line
There is no iron-clad rule about when to refinance, and the tumultuous economic circumstances of the pandemic have given important pros and cons to consider. For those who struggle to make payments or want lower monthly payments, the best choice may be to stay with a federal program. If you are able to pay off your loan more aggressively, a timely refinance could provide a unique opportunity to capitalize on inflation before interest rates rise in the future.
Press Release Service by Newswire.com
Original Source: The Impact of Inflation on Student Loan Debt
