How Inflation Impacts Student Loan Borrowers

It seems like historic things happen every other week right now. So it’s fitting that we’ve seen inflation in 2022 higher than at any time since 1980. This impacts you as a student loan borrower in a number of different ways depending on the type of repayment approach you’re taking with your loans.

If you’re careful, you can mitigate the effects of inflation on your financial situation or perhaps even take advantage of it.

How did this inflation get here?

In the most recent Federal Reserve report from October 2022, the U.S. experienced 7.7% inflation over the prior 12 months. That’s over three times the Federal Reserve’s inflation target of 2%!

Post-lockdown in the US

Inflation is coming from several different places. First, during the COVID-19 pandemic, the lockdowns across the country made shopping, entertainment and travel much more difficult.

Despite all the negative effects of the pandemic, many people continued to have disposable income, but they couldn’t spend it in the ways they used to. This resulted in pent-up demand being released when lockdowns were lifted, and people were more comfortable doing what they used to do.

This pent-up demand was met with significant supply chain issues due to the pandemic. Take cars, for instance: the supply chain for new car parts was running so far behind production that new cars were hard to come by, with new vehicles selling over MSRP. This led new car buyers to purchase used vehicles instead, inflating those prices as well.

War and sanctions abroad

Then, the conflict in Ukraine began. Both Russia and Ukraine are very important energy and food producers. Russia is the world’s third-largest oil producer, and due to recent sanctions, most of the world is no longer able to purchase that oil. This has led to increased gas prices for your car and possibly heating costs for your home.

What’s more, in 2021, before the conflict began, either Russia or Ukraine (or both) were ranked in the top three global producers of wheat, corn, barley and other crops. This food, if produced in Russia, is now illegal for most of the western world to purchase, and if produced in Ukraine, is very difficult to export due to the fighting within the country. This means you’re paying higher food prices at the store as well.

How inflation affects borrowers paying their student loans to zero

If you’re making a fixed payment on federal or private student loans with the intent to pay your loans off, then you should be celebrating inflation. That’s because your monthly payment doesn’t change, but the value of the dollars you’re using to make that payment goes down.

Put a bit more simply, your income may inflate assets or investments you have may inflate, but your student loan payment won’t change.

What’s more, if your student loan interest rate is lower than the inflation rate (again, 7.7% for the year ending October 2022), then you’re actually making money on the difference. If you’re paying, let’s say, an average of 5% on the balance, but the whole balance went down in value by 7.7% due to inflation, you actually made 2.7% in inflation-adjusted net worth!

To combat inflation, the Federal Reserve has raised short-term interest rates, which tend to impact longer-term interest rates over time. This has had the effect of raising interest rates on private student loans, which are market-driven.

So if you have a variable rate on your private student loans, you’ve likely noticed that your payment has increased. If you have a higher fixed rate in the federal system or with a private lender and you’re looking at refinancing, you’ll find that rates are slightly higher than they were six months ago.

How this affects borrowers working toward forgiveness

If you’re making income-driven payments and working toward forgiveness on your federal loans, then higher inflation may impact you by increasing your income faster than expected.

For those working toward PSLF, it’s likely not a big deal. You may have to pay slightly more on your income-driven payments due to your income increasing. However, as long as your annual income is less than your loan balance for most of those 10 years, PSLF likely still makes sense.

However, if you’re working toward income-driven forgiveness — a 25-year term on REPAYE and IBR or a 20-year term on PAYE — then lingering inflation could raise your pay enough over time that it may not make sense to work toward forgiveness.

Your income-driven payments may end up being high enough that you pay your loans off before reaching the forgiveness finish line. If this is the case, you can save a significant amount of money by getting a fixed payment now with the lowest interest rate possible and working toward paying the loans off instead.

What does inflation mean for new borrowers?

With raised interest rates, borrowers who are currently, or are about to be, in school will find that their student loans will cost a bit more than someone who graduated in the past few years.

Private student loan interest rates are market-driven and have increased about 1% to 1.5% year-to-date, according to a Student Loan Planner® analysis. Interest rates on federal student loans, however, are set once a year in June based on a calculation on top of the 10-year US treasury yield, which has gone up just over 2% this year.

Students taking out federal direct unsubsidized loans for the ’21-’22 school year have interest rates of 3.73%. Loans to borrowers in the 2022-23 academic year are priced at 4.99%, and it’s probably safe to assume that interest rates for the second half of 2023 year will be a little bit higher.

Fortunately, federal student loan interest rates are capped, and we’ll never see double-digit interest rates on unsubsidized Stafford Loans.

So for new borrowers, especially in the past year or two, your fixed payments will be a little bit higher due to higher interest rates. And with the new income-driven plan possibly being released by the end of next year, it may make sense for you to pay income-driven payments and work toward forgiveness.

The Bottom Line

Inflation is one of a myriad of factors that impacts how you handle your student loans. It may make certain options less viable, perhaps refinancing to get a lower rate. It also may make other options more viable like making income-driven payments to work toward forgiveness.

It’s worth asking yourself whether you think your income will move up faster than anticipated due to the inflation we have now. The answer is clearer for professions where contracts are negotiated with cost-of-living adjustments or yearly step-ups. It’s more difficult to estimate for professionals without those arrangements.

If you’re concerned about whether inflation may affect your loan repayment or progress toward forgiveness, work out the numbers with an expert. Book a consult with one of our student loan advisors!