What The Federal Reserve’s Interest Rate Cut Means for Student Loan Borrowers

On Wednesday, the Federal Reserve made a long-anticipated announcement that it will be cutting interest rates by 0.5%. The decision was made after several economic indicators suggested that inflation was tapering off and the job market was contracting — signs that higher interest rates have done what policymakers intended for them to do and rates should now come down to avoid causing damage to the labor market.

“Recent indicators suggest that economic activity has continued to expand at a solid pace,” said the Federal Reserve in a statement.  “Job gains have slowed, and the unemployment rate has moved up but remains low. Inflation has made further progress toward the Committee's 2 percent objective but remains somewhat elevated… In light of the progress on inflation and the balance of risks, the Committee decided to lower the target range for the federal funds rate by 1/2 percentage point to 4-3/4 to 5 percent.” The Fed indicated that additional rate cuts are likely in the coming months.

The Interest rate reduction set by the Federal Reserve this week will not necessarily have an immediate impact on the economy. But the rate cuts will eventually trickle down to various sectors, including — for some — student loans. However, not all student loan borrowers will be impacted equally, or at all, by these developments.

Here’s what borrowers should know.

Impacts of interest rate cuts on current federal student loan borrowers

Most federal student loans have fixed interest rates set at the time of their disbursement. This means that the interest rates are set in stone and do not change with market conditions. This is also true for federal Direct consolidation loans, where the interest rates are fixed based on the weighted average of the rates of the underlying loans included in the consolidation, rounded up to the nearest eighth of a point. 

As a practical matter, a substantial portion of federal student loan borrowers are currently in a no-payment, no-interest forbearance as a result of the SAVE plan's legal challenges. The recent announcement by the Federal Reserve will not impact that forbearance or the associated interest-related benefits.

Thus, the interest rate cuts will not have any measurable impacts on most federal student loan borrowers currently in repayment.

Related: How Does Student Loan Interest Work?

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Impacts on interest rate cuts on new federal student loans

The interest rates for new federal student loans for the upcoming academic year have already been announced and are at record highs.

“On July 1, interest rates for new federal student loans rose to their highest levels since before the Great Recession,” said the Consumer Financial Protection Bureau (CFPB) in a statement issued last week. Interest rates for new undergraduate federal student loans increased by 19% compared to a year ago, and 44% compared to five years ago, said the federal financial watchdog agency. The Federal Reserve’s interest rate cuts will not alter these interest rates for newly-originated federal student loans. 

“Federal student loans are unusual compared to many private credit products because interest rates are fixed by a formula defined by Congress,” explained the CFPB. “Even if interest rates decrease for future student loan originations, the rate on federal student loans remains the same throughout the repayment period. As a result, borrowers who take on federal student loans this year will always make higher payments than others who borrow in a lower interest rate environment.”

The good news is that the Federal Reserve’s cuts this week, coupled with anticipated further interest rate reductions in the coming months, should bring down federal student loan interest rates for new disbursements in subsequent academic years. So, interest rates for the 2024-2025 academic year may really be the peak. 

Impacts of interest rate cut on private student loans depend on rate type

Whether private student loan borrowers will be impacted by the interest rate cuts depends on the type of rate that their loans have.

Private student loans with fixed interest rates are not much different from their federal counterparts in that the interest rate is set at the time of the loan’s disbursement and does not change with market conditions. So, borrowers with fixed-rate private student loans will see no change to their interest rates following the Federal Reserve’s announcement. 

But private student loan borrowers with variable rate loans may start noticing some changes. 

Variable rates mean that the interest rate changes with economic conditions. While the rates aren’t necessarily directly tied to the rates set by the Federal Reserve, the Federal Reserve’s interest moves do wind up trickling down to other elements of the economy, which should generally reduce interest rates across the board over time. 

So, borrowers with private student loans with variable interest rates may start seeing those interest rates come down in the coming months. This will be welcome news for those who have seen their monthly payments increase during the last couple of years as a result of the historically high interest rate environment. 

Impacts of interest rate cut on private student loan refinancing

Refinancing student loans can be risky for some borrowers, particularly those with federal student loans. Refinancing federal student loans through a private lender is a one-way ticket out of the federal student loan system, meaning that these borrowers would be walking away from all of the programs and consumer protections of the federal student loan system. This includes loan forgiveness and discharge programs, pathways out of default and generous deferment and forbearance options.

But refinancing can make a lot of sense for certain borrowers with high-interest private student loans — particularly those locked into high-interest, fixed-rate loans. 

While the Federal Reserve’s interest rate cuts this week will not necessarily have immediate impacts on the private student loan refinancing market, as the latest cut and subsequent reductions percolate through the economy the rates on new private student loan refinancing products will hopefully start to come down. 

In the coming months, certain borrowers may have a prime opportunity to refinance their loans to get lower interest rates and more affordable monthly payments.