Inflation reached a 40 year record 8.5% in March and fell slightly to 8.3% in April. In times of high inflation, such as now, your dollar is worth less. You may have also heard that there is an upside – that your student debt is now worth less. And while that’s technically true, that’s not the whole story.
The current pause on federal student loan repayments has been extended through August 31, marking the sixth extension since the pandemic began. While this freeze offered temporary relief to borrowers, when repayments begin inflation will play a key role.
What is the exact impact of inflation on your student debt? We sat down with student loan expert Mark Kantrowitz, author of How to Appeal for More College Financial Aid, to discuss the specifics of what inflation means for student loan holders.
What are inflation rates and interest rates?
Inflation rates are a measure of the purchasing power of money. The Federal Reserve, the central banking system of the United States, is responsible for keeping inflation around 2% each year, the standard annual growth rate of the economy. When inflation rises above the 2% mark too quickly, as it has in recent months, the prices of goods and services rise, requiring more money for basic necessities and housing. This indicates a period of high inflation.
For example, in 2018 you could buy about 2 gallons of milk for $6. Today, however, that same amount of money will only buy you about 1.5 gallons of milk.
Interest rates represent the cost of borrowing. An interest rate is the amount a lender charges a borrower, which is a percentage of the total loan amount. For example, if you borrow $1,000 with an annual interest rate of 5% for a four-year term, your total interest costs would be $105.41 over the four-year term.
As inflation rises, the The Fed raises the federal funds rate, which is the rate it costs banks to lend to each other. Banks then react by raising consumer interest rates on loans and other financial products. The Fed does this to contain inflation, which makes it less attractive for consumers to borrow money, which helps balance supply and demand, stabilizes the economy and, theoretically, lowers the interest rate. ‘inflation.
How Inflation Affects Your Student Loans
The rate increases will not affect existing fixed rate student loans, such as federal loans. Private borrowers with adjustable rate mortgages, however, could see their rates increase.
Moreover, in times of high inflation, the value of fixed rate student loans also decreases. “Inflation dictates that a dollar ten years ago is worth more than a dollar today. So as long as your wages increase with inflation, debt from a loan borrowed in the past will be worth less. today,” Kantrowitz said.
Essentially, if your wages rise in line with inflation at the same rate or more, it can make it a little easier to pay off your debt. However, average wage increases are currently not keeping up with inflation. As of March 2022, wages had risen only 5.6% over the past 12 months. This means that most Americans will not currently benefit from devalued student debt.
Here’s a breakdown of the impact inflation could have on you depending on your loan type and whether or not you’re still in school:
If you have federal student loans:
Federal student loans are fixed rate. This means that the interest rate will remain the same throughout the term of the loans.
If you have a federal student loan, inflation could work in your favor if your salary increases in line with the rate of inflation, as this will devalue your debt.
However, if, like most Americans, your wages have not increased at the same rate of inflation and rising prices stretch your budget even furtherthat devalued debt won’t help you – and you might even find it harder to repay your loans.
If you have private student loans:
Private student loans can be variable or fixed rate. For those with fixed rate loans, you don’t have to worry about inflation raising interest rates on your existing student debt. But if you have adjustable rate loans, your interest rates could go up – and may have already.
When inflation rates rise, interest rates generally follow. This means that holders of variable rate private loans could see higher interest rates in the future.
If you are a new borrower in 2022:
Federal student loan interest rates reset annually on July 1, and Kantrowitz noted that federal and private student loan interest rates will be higher for the 2022-23 academic year. The new federal student loan interest rates for the 2022-23 school year were just released this week and are as follows:
- Undergraduate loans: 4.99%
- Direct unsubsidized loans to graduates: 6.54%
- PLUS Loans: 7.54%
This is a big leap for students. For reference, last year a federal undergraduate student loan had an interest rate of 3.73%, about 1.25% lower than the rate for the upcoming academic year.
Will inflation impact loan repayments after federal payment freeze ends?
Kantrowitz said he expects the student loan repayment pause to be extended again, with renewed payments beginning after the 2022 midterms. However, whether or not the repayment freeze is extended may depend on the House’s decision. white on widespread remission of federal student loans (President Joe Biden is expected to make a decision on this in the coming weeks). As anything can happen, it’s best to prepare for repayment now, so you won’t be surprised if loans are due again in September.
For many, paying off student debt in times of high inflation is a real concern. According to the Student Debt Crisis Center, out of 23,532 borrowers, 92% of those working full time fear they will be able to pay in the face of soaring inflation.
“I personally couldn’t save to pay off a student loan, and I don’t think I could have accounted for the growing gap between wages and the national cost of living,” said Jonathan Casson, recently graduated from Cornell University.
If you’re worried about paying off your student debt, here are some tips for planning ahead:
How can you prepare to repay federal loans?
1. Look into income-driven repayment plans
The government offers four income-based repayment plans that can help make monthly payments more affordable for borrowers who need to reduce the size of payments. Each plan caps payments at between 10% and 20% of your discretionary income (income after taxes and necessities paid for) and cancels your loan balance after 20 or 25 years of payment. Eligibility for these plans depends on family size and discretionary income.
2. Refinance private loans now
With many interest rate hikes expected this year, refinancing all the variable rate private student loans you have into fixed rate student loans could help you save hundreds, if not thousands, in interest – and could even reduce your monthly payment. You should refinance as soon as possible, however, if you want to lock in the lowest possible fixed interest rate.
3. Consider your budget carefully
If paying off a student loan isn’t feasible with your current budget, see if there are ways to cut expenses or pay off high-interest debt now to free up cash in September. While adjusting your budget can seem daunting, there are plenty of resources and apps to help you calculate and identify expenses you can reduce or eliminate.
4. Consider secondary agitation
A part-time job outside of your main job can help supplement your income when inflation spikes. Currently, about a third of American adults have a side job, according to a 2021 Harris poll commissioned by Zapier. Another source of income can help fill an income gap in your budget and give you some respite.