How Inflation may Impact Student Loans

A creditor charges a borrower an interest rate, which is calculated as a percentage of the entire amount borrowed. 

The Federal Reserve increases the fed funds rate, which is the rate at which banks lend to each other, when inflation goes up. Banks respond by raising loan rates and other financial services for consumers. The Fed does this to keep inflation in check by making it more difficult for people to borrow money, which helps to stabilize supply and demand, bolster the economy, and ideally cut inflation.

How inflation may impact student loans

Many student loan debtors have not made any repayments in almost two years. In March 2020, the US Department of Education implemented many relief measures in response to the COVID-19 pandemic, including suspending all federal student loan payments and freezing interest rates at 0%.

Inflation reached a 40-year high of 8.5 percent in March before easing to 8.3 percent in April. The value of dollar depreciates during periods of severe inflation, such as the current one. The current suspension on federal student loan repayments has been prolonged until August 31, the sixth time since the outbreak began. While the suspension has provided immediate respite to debtors, inflation will contribute significantly once repayments commence.

This deferral period was only supposed to last a few months at first, but it has since been extended six times since then. This implies that debtors with federal student loans will are expected to resume their debt and repayments on Sept. 1, 2022, where they left off.  In any case, the economy has changed dramatically in the previous two years. Inflation, which is now growing at a rapid rate, has been one of the most significant developments.

Initial fixed on federal student loans will not be affected by rate hikes. Borrowers with adjustable-rate mortgages, on the other hand, may see their rates rise.

The worth of fixed-rate student loans falls during periods of strong inflation. According to Mark Kantrowitz, author of How to Appeal for More College Financial Aid, the worth of a dollar from 10 years ago is worth more than a dollar today.  As a result, as long as earnings rise in synch with inflation, the debt for a loan taken out in the past will be worth less today.

Fundamentally, if wages go up at the same or faster pace than inflation, it will be easier to repay your debt. Average pay gains, on the other hand, are presently falling behind inflation. Wages had barely climbed by 5.6 percent since March 2022.

Meanwhile, rising interest rates increase the cost of borrowing generally, if you have a credit card or are trying to take out a personal loan. This rate rise will also affect federal student loans with fixed rates, but it will only affect those who take out such loans in the future.

Students with current federal student loans may benefit from fixed interest rates that aren't affected by market conditions, but private student loan borrowers may not be so fortunate. Most private student loans, in fact, have variable interest rates that increase over time.

Sadly, even a 0.5 percent or 1% increase in interest rates can result in significant increases in monthly payments and overall interest costs. For example, suppose you're starting payments on a $20,000 student loan with a current interest rate of 5%. A 10-year payback plan would result in a monthly payment of $212.13.

Federal student loans have a fixed interest rate. This indicates that the interest rate will remain constant during the loan's duration. If you have a federal student loan, inflation may work in your advantage if your wages grow in tandem with the rate of inflation, since your debt will depreciate.