Inflation has been making headlines for the last few months, as prices for everything, from food to housing, continue to increase to levels unseen in 40 years.
In a move to bring things back to normal, the Federal Reserve increased interest rates by 0.25% last week — and that’s just the tip of the iceberg. Since inflation is currently at 7.9%, the Fed could raise interest rates six more times throughout the year to reach its 2% goal.
With student loan payments set to restart in May, you may be wondering how this will impact your loans and your monthly budget.
Today, I’ll walk you through the ins and outs of high inflation regarding your student loans and ways you can prep yourself financially for what’s coming.
Inflation could be a good thing for student loan borrowers
A recent survey conducted by the Student Debt Crisis Center and Savi, a social impact startup, revealed that 92% of student loan borrowers are concerned that inflation will make it harder to repay their loans. Some are skimping on things like food and healthcare amid fears that their budgets may come up short once repayment resumes.
But Landon Tan, CFP and financial advisor at LPL Financial, says that we shouldn’t be too worried about it, as “inflation is generally going to work in favor of student debtors.”
According to the Education Data Initiative, most student loan borrowers have federal student loans, which have a fixed interest rate. That means that regardless of what’s happening with the economy right now, your interest rate will remain the same over the life of the loan.
“So the payments will stay the same even as other things, including salary, go up,” Tan says.
And he makes an excellent point, too.
When there’s inflation, many companies offer their employees a pay raise. They do this for two reasons: first, to keep them from looking for a better-paying job elsewhere, and, second, to help them cope with the rising cost of living.
If your company does give you a raise, and you have federal student loans or fixed-rate private student loans, Tan says you’re golden.
Since your interest rate will be the same as when you were earning less, your student loan payment will now represent a smaller portion of your paycheck, leaving you with more wiggle room for other expenses.
However, there’s one caveat.
Due to all the strain caused by the pandemic, companies are working with a smaller budget. So, getting a big pay raise may be difficult. In fact, according to the Society for Human Resource Management, only 44% of companies in the U.S. are planning to give their employees a pay increase higher than 3% this year.
“If inflation makes life more expensive, and your salary doesn’t increase accordingly, Tan says there will be less money to pay the loan back,” Tan says.
In other words, to benefit from this situation, you need to have a fixed-rate loan and get a substantial raise from your employer.
When inflation means bad news for your student loans
There isn’t much to worry about if you have federal student loans or fixed-rate private student loans, as lenders can’t change your interest rate or how much you pay each month.
But if you’re like me and have a mix of both federal student loans and private student loans with a variable interest rate, that’s when things can get a bit tricky.
“The Federal Reserve has interest rate hikes already planned, and reducing inflation is one reason they raise these rates,” Tan says. “When those rates go up, consumers’ variable rates should go up correspondingly — including your variable rate student loans,” he adds.
So, if you have private student loans with a variable rate, it is very likely that your lender will raise your interest rate, which means that your minimum payment due could also go up, eating away a more significant chunk of your budget.
And, if inflation persists, and you still have a long way to go before paying off your debt, that also means you could end up paying hundreds more on interest over the life of the loan.
“The problem is we don’t know exactly where or when rates will land,” Tan says.
Likewise, if your employer gives you a pay raise and you have federal student loans under an income-driven repayment plan, your payments could go up.
As you may or may not recall, when you’re in an income-driven repayment plan, your monthly payment is adjusted to 10% of your discretionary income. So, if you’re earning more, it’s very likely that you’ll have to pay more each month.
What you can do to lower your payments
“Many borrowers have a mix of government and private loans,” Aaron Smith, co-founder of Savi, says. “That’s very common, and one of the things we tell people is that you need to treat those two loans very differently.”
So, here are some options you can explore to make your payments more manageable, depending on the type of student loans you have.
If you have federal student loans…
If you’ve been making standard payments — or none at all during the two-year repayment pause, then applying for an income-driven repayment plan can be a good idea to lower your student loan payment.
As I already mentioned, these plans adjust your minimum payment due based on 10% of your discretionary income, which can be a huge relief for your wallet.
You can apply for an income-driven repayment plan by logging into your account on studentaid.gov or contacting your student loan servicer.
If you’re a teacher, a nurse, work in the public sector, or a nonprofit organization, Smith recommends applying for the Public Service Loan Forgiveness Program (PSLF).
Under this program, eligible student loan borrowers can get their debt forgiven after making 120 consecutive payments.
Besides PSLF, other government and state programs will help you pay off your debt for working in one of the sectors mentioned above.
If you’d like to learn more, visit your state’s government website to see what you may be eligible for.
If you have private student loans with a variable interest rate…
Sadly, private student loans don’t offer any income-driven repayment plan options or anything like that. So, the best thing you can do is see if you can refinance your loans to swap your variable interest rate for a fixed one.
However, this only makes sense if your income has substantially improved since you took out the loan and have a stellar credit score. Otherwise, you won’t be able to secure the best terms or interest rates.
Okay, you’re probably thinking, ‘how’s that gonna help?’ Hear me out.
Most private lenders offer a 0.25% discount on your loan’s interest rate for signing up for automatic payments. And, since the Fed raised rates just by 0.25% (at least for now), this little discount could help even things out for you.
Being a student loan borrower in these uncertain economic times can be challenging. Still, you can make things work with some careful planning.
The most important thing is to take action now and not wait until the last minute to look into your repayment options.
Featured image: Who is Danny/Shutterstock.com
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