This has already been a tough year for college applicants, starting with issues with a key federal form that delayed the delivery of financial aid. Now students and their families have an added worry: The cost of borrowing to attend college for the next academic year has risen to its highest level in more than a decade.
The Department of Education announced last week that interest rates on new federal student loans for undergraduate students will rise to 6.53% as of July 1, up from 5.5% this year.
Interest rates on graduate and professional student loans will rise to 8.08 percent, and interest rates on PLUS loans, additional financing available to parents of undergraduate and graduate students, will rise to 9.08 percent.
Federal student loan interest rates are based on a formula set by Congress that combines the highest yield on 10-year Treasury notes offered at the May auction with an additional fixed rate based on the type of loan. The yield at the May 8 auction was 4.483 percent, plus a 2.05 percent yield on undergraduate loans. (The yield at last year's Treasury auction was 3.448 percent; yields on graduate and PLUS loans are higher.)
Interest rates generally remain high as the Federal Reserve works to combat inflation. Still, interest rates on new student loans seem especially steep compared to just a few years ago, said financial aid expert Mark Kantrowitz. The interest rate for undergraduate loans for the 2020-21 school year was 2.75%. Still, in the early 1980s, rates were as high as 14%, Kantrowitz said.
The new interest rates will apply to loans taken out between July 1 and June 2025 and will remain fixed for the life of the loan. They will not apply to loans that students have already taken out.
By Kantrowitz's calculations, that would mean a roughly $5 increase in monthly payments on a $10,000 debt over a 10-year repayment term.
Interest rates are rising amid growing concerns about student loan debt and the high cost of college. As of the beginning of 2024, about 43 million borrowers had an average of about $37,850 in federal student loan debt, according to the Department of Education's Office of Federal Student Aid.
Nearly half of American adults (47%) say a college degree is worth the cost, but only if you don't have to take out a loan to get it, according to a survey released Thursday by the nonpartisan Pew Research Center. Fewer than a quarter (22%) say it would be worth the cost even if you didn't have to take out a loan.
Pew Research Center also analyzed federal data and found that households headed by young people with high school degrees will have an average net worth of $30,700 in 2022, compared with $120,200 for those headed by young people with college degrees.
Michelle Sheppard Zampini, senior director of college affordability at the nonprofit Institute for College Access and Success, said students should put the new federal loan rates, and borrowing for college, in perspective.
“Interest rates are higher than we'd like, but that's OK,” she said. “I never want to see anyone not go to college just because they have to take on federal student loans,” she added.
Zampini says the institute advises borrowers to “borrow what you need” to cover costs and fully participate in college life. Generally, undergraduates who are supported by family members can borrow up to $31,000 in federal loans. (There are annual limits on how much you can borrow, and the limits are higher for independent students.)
Some students might be tempted to borrow significantly less, thinking they could cover the costs by working more, but that “often works to the student's detriment,” Zampini said, because they might end up studying too much and falling behind in class. “It's definitely a balance.”
Zampini said students should compare the costs of different colleges and consider choosing a less expensive option, such as a public university instead of a private one, to keep costs down. Check the school's graduation rate and career outlook. Students who typically take longer than four years to graduate will pay more for their degree. (One place to look at this is the Department of Education's Online College Scorecard.)
Zampini said the new, more generous federal student loan repayment plan, known as SAVE, is a “safety valve” for students worried about paying back their loans. SAVE stands for “Saving on a Valuable Education,” and repayment amounts are based on income and the number of people in your household. If you make monthly payments for a set period of time (as little as 10 years, depending on the amount borrowed), the remaining balance will be forgiven.
Some low-income workers can reduce their SAVE payments to zero, and if a borrower's monthly payments don't cover the interest, the Department of Education will forgive any unpaid interest. Unpaid interest doesn't increase the loan balance.
Saving in a 529 plan can help reduce the amount you borrow. A 529 plan is a tax-advantaged savings account designed to help cover college costs. Named after a section of the tax code, contributions to the account grow tax-free and can be withdrawn tax-free for expenses like tuition, housing, food, and books. (Contributions to a 529 plan aren't federally tax deductible, but many states offer them.)
“529 plans are a useful tool,” said Tony Cure, managing director for the Northeast Ohio market at asset management firm Johnson Investment Counsel.
Wu recommends opening a 529 account when your child is born, then giving yourself time to build up the funds as much as possible before they go off to college, and if you have multiple children, he recommends opening separate accounts for each one.
Many 529 plans are offering promotions and incentives to help you save during the month of May, so if you've been thinking about opening an account, now is a good time to do your research.
Here are some questions and answers about student loans.
How much should I borrow for college?
Kantrowitz said you should aim for your total student loan debt to be less than your expected starting salary. If your debt is less than your income, you should be able to pay off your student loans within 10 years, he said. To get an idea of how much you could make, check out the Department of Labor's salary data by occupation. You could also look at a report released last year by research and consulting firm HEA Group on salaries by college major.
Can you get a better interest rate on a private student loan?
Kantrowitz said interest rates on some private student loans (offered by banks, not the federal government) may be competitive with the new federal rates for borrowers with excellent credit scores (780 or above). But private loans can be riskier because they don't offer the protections that federal loans offer, such as the right to pause payments in the event of financial hardship, income-linked repayment plans or the option to have some of the debt forgiven.
Can I deduct student loan interest on my federal tax return?
Even if you don't itemize on your tax return, you can generally deduct up to $2,500 of the amount you pay in interest on federal and private student loans, Kantrowitz said.