What is interest?
Money borrowed through federal student loans will ultimately need to be paid back with interest – unless you’re borrowing Direct Subsidized Federal loans, which have such benefits as the government paying interest on the loan while you’re in school.
Interest is the cost of borrowing that is calculated as a percentage of the unpaid principal (i.e. remaining balance) of the loan. Therefore, you’ll want to be aware of how federal student loan interest rates are determined and how they can impact the amount you will need to repay.
How are interest rates calculated?
Federal student loan interest rates are reviewed and determined each year based on 10-year Treasury notes, plus a fixed interest, and are reset on July 1. Because there are a few different types of federal student loans, each type has a different calculation for interest rates. According to the Congressional Budget Office, the formulas used to determine the interest rates for Direct Subsidized, Direct Unsubsidized, and Direct PLUS Loans are as follows:
- Direct Subsidized and Direct Unsubsidized Loans: 10-year Treasury note + 2.05%, with a cap at 8.25%
- Direct Unsubsidized Loans for Graduate Students: 10-year Treasury note + 2.05%, with a cap at 9.50%
- Direct PLUS Loans: 10-year Treasury note + 4.60%, with a cap at 10.50%
Now that we understand how federal student loan interest rates are calculated and set, let’s look into what the current interest rates are for the 2020-2021 academic year.
What are the current federal interest rates and origination fees?
The current interest rates and origination fees for the different types of federal student loans with a disbursement date (i.e. the date in which the student aid is issued to the borrower or their school) between July 1, 2020 and July 1, 2021 are:
- Direct Subsidized Loans (Undergraduate): These loans currently have a fixed interest rate of 2.75% and are only offered to those undergraduate students who’ve demonstrated financial need as defined by federal law. The government pays interest on the loan while the undergraduate student is in school at least half time, during deferment (a period when loan payments are temporarily postponed), or during the grace period (typically the first six months after graduating). Direct Subsidized Loans issued between October 1, 2019 and October 1, 2020 have an origination fee of 1.059%.
- Direct Unsubsidized Loans (Undergraduate): These loans share the same fixed interest rate as Direct Subsidized Loans, currently 2.75%, but are not based on financial need. The government does not pay the interest on Direct Unsubsidized Loans. Direct Unsubsidized Loans issued between October 1, 2019 and October 1, 2020 also have an origination fee of 1.059%.
- Direct Unsubsidized Loans (Graduate/Professional): These loans are available for graduate or professional students at a current fixed interest rate of 6.08%. Similar to its undergraduate counterpart, the government does not cover the interest on Direct Unsubsidized Loans for any period. Direct Unsubsidized Loans for graduate and professional students issued between October 1, 2019 and October 1, 2020 have an origination fee of 1.059%.
- Direct PLUS Loans: These loans are unsubsidized, credit-based federal loans for parents of dependent students and have a current interest rate of 5.30%. Interest for these loans is charged throughout all periods of the loan. Origination fees for Direct PLUS Loans issued between October 1, 2019 and October 1, 2020 are 4.236% of the total loan amount.
There are a variety of federal student loans available but it’s important to understand how they work, and which one is right for you. Make sure to carefully review your options to make the most informed decision about how to pay for college.