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Fed rate hike will boost costs of variable-rate student loans

For most of the nearly $1.4 trillion in U.S. student loan debt, the Federal Reserve interest rate hike means nothing -- for now.

That's because 92.5 percent of those loans are from the federal government and carry a fixed rate.

The rate on federal student loans is determined by Congress. Under current law, rates are set by a formula based on the auction of 10-year Treasurys each year for loans disbursed on July 1 through the following June 30.

So while rates on existing student loans will stay the same, those on student loans next year could rise on expectations that the government will have to borrow more to fund President-elect Donald Trump's plans to cut taxes and boost infrastructure spending. In fact, those expectations have already pushed 10-year Treasury yields higher.

"When you look at what's happened to long-term rates since the election, it might seem inevitable that rates on government student loans taken out after June 30, 2017, will be higher than they are today," said Stephen Dash, CEO of Credible.com, an online marketplace for lenders that offer student loan refinancing.

If 10-year Treasury yields stay at 2.6 percent, rates on new federal student loans will be about 0.9 percent higher than they are today. (See table below.)

Remember that Treasury yields can cut both ways.

"If Trump's stimulus plans fall flat, or if there are other unexpected shocks to the economy, we could see 10-year Treasury rates come down before the May auction," Dash said.

Even if 10-year Treasurys remain at 2.6 percent in May, it would have a small effect on borrowing costs for most people.

For example, a 2017 college graduate with $37,000 in student loans would pay nearly $1,900 more in interest over the life of the loan, or $16 extra each month, under a standard 10-year repayment plan than a graduate this year if T-note yields are at 2.6 percent in May.

Why? Because as yields on 10-year T-notes rise, federal student loans will increase by a similar amount.

Private student loan rates

Roughly 7.5 percent — about $102 billion — of U.S. student loans are privately financed, according to MeasureOne, a higher education data analytics firm.

Private student loans have fixed and variable rates. Nearly a quarter of student-loan borrowers didn't know the difference between fixed and variable rates, according to a recent survey by Credible of 699 borrowers.

Student loans from private lenders generally are set by Libor or prime rates, which closely track the federal funds rate over time. So the Fed rate hike will affect these loans.

People with variable-rate student loans may not experience a big increase in their borrowing costs now, but may feel the pain of multiple rate hikes.

"A 25-basis-point increase isn't really going to move the needle and won't sway many people to refinance their variable-rate loans," said Max Spiegel, chief operating officer of Student Loan Hero, a website that provides free tools to help borrowers manage their debts.

Student loan refinancing

With student loan refinancing, creditworthy borrowers can get lower rates, change the repayment terms of their student loans and potentially save thousands.

Private student loans do come with some drawbacks. Borrowers who refinance with private lenders can't take advantage of income-based repayment plans and public service loan forgiveness provided by federal loans.

Rates would have to go higher to slow the growth of the student loan refinancing market.

"Borrowers who refinance into shorter-term loans reduce their rates by 1.7 percentage points on average, so rates would have to come up quite a bit before they lose that advantage," Credible.com's Dash said.