Borrowing for College Just Got a Little Less Expensive

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There's good news for college students and parents who plan to take out loans to help pay for school. New federal student loan interest rates went into effect July 1, and this year, the rates dropped for the first time in three years. 

• Undergraduate loan rates are 4.53 percent for the 2019-2020 academic year, down from 5.04 percent in 2018-2019.
• Parent PLUS loans are 7.08 percent, down from 7.60 percent.
• Graduate school loans are 6.08 percent, down from 6.60 percent.

(Federal student-loan rates are fixed, so they won’t go any higher over the life of the loan. But the rates are reset annually and only apply to new loans, not those you've already taken out.)

The decline follows a downward trend in interest rates on most consumer loans since the Federal Reserve decided earlier this year to hold rates steady after four increases in 2018.

Still, a half percentage point decline won’t significantly change monthly payments for undergraduates. That’s because the amount they can borrow is limited by the government, from $5,500 to $12,500 depending on what year they're in school and whether or not their parents claim them as a dependent.

For example, with the new rates, a freshman who takes out $5,000 and pays it back over 10 years will save $150 in interest over the life of the loan.

“Borrowing is not so cheap that you should overborrow,” says Shannon Vasconcelos, a college finance expert with Bright Horizons College Coach.

Nevertheless, the decrease is welcome. As college costs have risen, so has the number of people relying on loans to pay for school. About 65 percent of students who graduated from a four-year college say they had to borrow money to cover the cost.

The drop could be more meaningful for graduate students and for parents who take out  federal Parent PLUS loans, because there's almost no limit on the size of those loans, says Vasconcelos.

Graduate students and parents can borrow up to the total cost of school. The typical graduate student borrows amounts that pay for half the cost of school, on average, $25,000 a year, according to Sallie Mae’s "How America Pays for Graduate School" report. A graduate student who takes out $50,000 in loans will save $1,500 under the new rates.

Meanwhile, the amount of debt parents are taking on to help their children pay for school is rising even faster than the debt assumed by undergraduate students themselves. Americans ages 60 and older are the fastest-growing group of student-loan borrowers, primarily because they're taking out loans to help children and grandchildren, according to the Consumer Financial Protection Bureau.

But many students and parents who borrow have little understanding about how their loans work or how a change in interest rates could affect them.

Only about half of students and parents know that they aren't guaranteed to get the same rate on federal loans each year they borrow, according to a 2018 Credible.com student-loan quiz. And only 14 percent of parents and students know that Parent PLUS loans have higher rates than undergraduate or graduate loans.

Loan Fees Will Be Lower and Grants Bigger

There's other good news for borrowers: Origination fees, which lenders charge for processing loans, are going down. For loans issued Oct. 1, 2019, through Sept. 30, 2020, fees will be 1.059 percent of the principal loan amount, down from 1.062 percent, and 4.236 percent for PLUS loans, down from 4.248 percent.

July 1 is also when changes to federal grants—money students don’t have to pay back—are made. The maximum Pell Grant is now $6,195, up from $6,095. Pell Grants help 7.5 million low- and moderate-income students pay for college and reduce how much they need to borrow.

Even with the increase, Pell Grants cover only a fraction of college expenses. The new maximum Pell Grant for 2019-20 covers less than 30 percent of the cost of attending a public four-year college, the smallest share in the grant program's history, according to The Institute for College Access & Success.

What You Should Know Before You Borrow

If you borrow money to pay for college, federally backed loans are the best way to do so because they come with more consumer protections than private loans, including flexible repayment plans and the ability to defer payment if you have a financial hardship. But even though rates are dropping, you should still be cautious about the amount you borrow.

Don’t borrow more than you can afford. A good rule of thumb is to limit your total borrowing to no more than what you expect to earn annually in the early years of your career. That can help you limit your monthly payments to no more than about 10 to 15 percent of your expected gross income.

So if you borrow $30,000—about average for college graduates—your payments will be about $300 a month. That’s a significant sum but should be doable even if you're making only a modest salary.

If your total student-loan debt at graduation is less than your annual starting salary, you should be able to repay your student loans in 10 years or less, says Mark Kantrowitz, publisher and vice president of research at Savingforcollege.com, a website that provides information on 529 education savings accounts and allows you to compare state-sponsored 529 plans.

But if more than 15 percent of your earnings goes to student-loan payments, you could struggle to pay and need to cut spending in other areas of your life. 

Of course, it can be difficult to know what your future earnings will be or what career you'll end up in. If you're really unsure, be even more conservative in your borrowing. Look for other ways to lower costs by finding cheaper housing, say, or choosing a less expensive meal plan.

“Don't borrow to the limit. Borrow as little as you need, not as much as you can,” says Kantrowitz.

Be wary of private loans. A private loan rate is typically variable, which means it's likely to rise over time, so you could end up owing a lot more in interest. If you have to borrow, federal loans are a better choice because they have fixed rates and the option of flexible repayment programs. That includes income-based repayment (which can make your loan payments more affordable), deferment if you return to school, or loan forgiveness options if you meet certain conditions.

Unlike private loans, federal loans don't require students have a co-signer or credit history. For parents, taking out federal student loans is also less risky than using home equity or tapping retirement savings to help kids pay for college.

Keep good records. Once you move into repayment mode, be sure you know what kind of loans you have and which company is servicing them. You will also need to keep records of what you owe and the payments you’ve made.

Save copies of important documents on a flash drive or in paper form. If you have federal loans, you can find the name and contact info for your servicer in this national database. If you have a private student loan, check your credit report to see which firm is listed as a servicer. You can get a free copy of your annual credit report once a year at annualcreditreport.com.

Want More Advice? Watch This Video

Paying for college isn't easy. Consumer Reports' money editor, Donna Rosato, talks to "Consumer 101" TV show host Jack Rico about how students and parents can make the most of financial aid options when paying for higher education. 

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