Student loan interest rates are influenced by a variety of factors, including the monetary policy of the Federal Reserve. But exactly how the Fed's decision to raise or lower its federal funds rate affects you depends on the type of student loans and interest rate you have.

If you're concerned about rising interest rates or simply want to better understand how student loan interest works, here's what you need to know.

How does the Federal Reserve influence student loan interest rates?

One of the purposes of the Federal Reserve is to help manage inflation in the U.S. economy. One way the central bank does this is by raising and lowering its federal funds rate — commercial banks charge this rate when lending to each other to meet overnight cash reserve requirements.

When the inflation rate exceeds the Fed's 2% target and remains elevated, the Federal Open Market Committee (FOMC) — made up of the Federal Reserve System Board of Governors and select Reserve Bank presidents — may increase the federal funds rate.

The prime rate, a benchmark rate that banks, credit unions, and other financial institutions use to determine interest rates for certain loans and credit cards, typically follows suit. As borrowing becomes more expensive, consumer spending typically decreases, resulting in the inflation rate coming back down.

Conversely, if the inflation rate is too low and the economy is sputtering, the FOMC may lower its interest rate, reducing the cost of borrowing money, which can result in more spending to enhance economic growth.

Federal student loan interest rates

The federal funds rate doesn't directly impact federal student loan interest rates, but it can do so indirectly. Instead of using the prime rate, Congress determines interest rates for federal student loans each year using the 10-year Treasury bill, adding on a margin.

The 10-year Treasury is not influenced by the federal funds rate. Instead, the yield on a 10-year Treasury bill is dictated by investor demand. When the inflation rate is high or investors anticipate high economic growth, they typically demand higher yields on long-term bonds, resulting in higher Treasury rates.

On the flip side, Treasury rates typically fall when investors expect slow economic growth and prefer the safety of risk-free government bonds.

If the FOMC successfully reduces inflation by manipulating the federal funds rate, the 10-year Treasury yield may also fall, resulting in lower federal student loan interest rates. Because federal student loans have fixed interest rates, the prime rate doesn't come into play, and your interest rate won't change after loan disbursement.

Private student loan interest rates

Private student loans are offered by private lending institutions, which use the prime rate to help determine which interest rates to charge their borrowers. As the Fed's interest rate increases, so will the interest rates offered on private student loans, and vice versa.

But because you can opt for either a fixed interest rate or a variable interest rate on a private student loan, the Fed's decisions may impact you differently.

If you opt for a fixed APR, your interest rate may be high if the federal funds rate is currently high, but it won't change over time. In contrast, variable interest rates fluctuate based on market rates. In other words, your interest rate can go up or down over time, depending on market conditions.

Interest rates for different types of student loans

Each year, Congress determines interest rates on federal student loans for the entire academic year by taking the 10-year Treasury rate on a specific date in May and adding a margin, which varies by loan type. On May 10, 2023, the 10-year Treasury note high yield was set at 3.448%, with the following margins.

• Direct Subsidized Loans and Direct Unsubsidized Loans for undergraduate students: 10-year Treasury yield plus 2.05% (fixed interest rate of 5.50%)

• Direct Unsubsidized Loans for professional students and graduate students: 10-year Treasury yield plus 3.60% (fixed interest rate of 7.05%)

• Direct PLUS loans for parents of undergrads and for professional students and graduate students: 10-year Treasury yield plus 4.60% (fixed interest rate of 8.05%)

These interest rates are standardized within each program. If you apply for financial aid with a Free Application for Federal Student Aid (FAFSA) application and qualify for a federal student loan, you'll receive the same rate as everyone else who qualifies in the same year.

On the other hand, private lenders determine interest rates using the prime rate and other benchmarks, as well as risk-based pricing. Instead of offering a standardized rate, they typically offer a range of interest rates, with the best student loan rates reserved for the most creditworthy borrowers and higher rates for borrowers with a higher risk of defaulting on payments.

Current student loan interest rates

For the 2024-25 school year, federal student loan interest rates are as follows:

Among private lenders, interest rates can vary depending on the lender, your creditworthiness and the type of interest rate you choose. That said, the typical fixed interest rate among top private student loan companies ranges from 4.65% to 14.70%, as of July 2024.

Student loan debt repayment plans

The U.S. Department of Education offers several different repayment plans for federal student loan borrowers. The repayment plan you choose won't have any impact on your interest rate, but it can affect your total interest charges.

The standard repayment plan on a federal student loan is 10 years, but if you extend it — options go as high as 30 years — you'll ultimately pay more interest over the life of your loan.

If you're having trouble making payments on your federal student loans, you can opt for an income-driven repayment plan, which can reduce your monthly student loan payment to as little as 5% of your discretionary income. Depending on which plan you choose, you may also receive forgiveness of your remaining balance after a certain point, which can range from 10 to 25 years.

However, if your monthly payment isn't high enough to cover the accrued interest, three of the four income-driven repayment plans will add the remaining interest to your balance. The SAVE plan is the only one that doesn't do this.

Do credit scores and co-signers also affect your interest rate?

You don't need a minimum credit score or a co-signer to qualify for federal student loans. However, if you're applying for private student loans, a bad credit score will likely prevent you from qualifying — you typically need a credit score in the mid-600s or higher to get approved.

Just because you qualify doesn't mean you'll get favorable terms — student loan companies reserve their highest loan amounts and lowest rates for borrowers with credit scores in the mid-700s and higher.

If you can't qualify for a private student loan on your own, or you can't get a low interest rate, you can improve your odds by adding a creditworthy co-signer to your application. A co-signer agrees to repay the loan if you can't, so the lender will also consider their credit score and income during the application process.

If you don't have a potential co-signer, improving your credit score is your best bet to qualify for a lower rate on a private student loan. Steps you can take include:

• Checking your credit score to evaluate your overall credit health.

• Reviewing your credit reports to pinpoint areas you can address.

• Paying your bills on time and, if applicable, getting caught up on missed payments.

• Paying down high credit card balances.

• Paying off loans with low balances.

• Asking a loved one with good credit to add you as an authorized user on their credit card.

• Disputing inaccurate or fraudulent information on your credit reports.

Will refinancing your student loans lower your interest rate?

Student loan refinancing involves replacing your existing loans with a new one through a private lender. Depending on your situation, refinancing could allow you to get a lower interest rate or a different repayment plan. If you have several loans, you'll also be able to consolidate them into one monthly payment going forward.

If you have private student loans and can qualify for better terms with a refinance loan, there aren't many downsides to refinancing. But if you have federal student loans, it's important to consider what you'll give up if you refinance them with a private lender. The process is irreversible and will result in you losing access to federal benefits, including student loan forgiveness and repayment assistance programs, income-driven repayment plans, and generous forbearance and deferment options.

Unless you have a stable job and income and the potential savings are significant, it's best to avoid refinancing federal student loans.

Will you save money with student loan refinancing?

Student loan refinancing can help you secure a lower monthly payment through a lower interest rate, a longer repayment term or both. But in instances where your new repayment term will be higher, you may wind up paying more in interest.

As an example, let's say you have $30,000 principal balance in private student loans with an average interest rate of 8%, a 10-year repayment term, and a monthly payment of roughly $364. If you qualify for a 6% interest rate and retain the 10-year repayment term, your new monthly payment will be about $333, and you'll save $3,711 in interest charges over the life of the loan.

If you get the 6% interest rate and extend your repayment term to 15 years, your monthly payment will drop even further to roughly $253, but you'll end up paying about $1,890 more in interest on the new loan.

In this instance, you'd need to consider the trade-offs of extending your loan term. If your budget is tight, a lower payment may be necessary but also more expensive in the long run. One way to mitigate the cost is to take advantage of the lower payment now, then once your financial situation has improved, refinance again with a shorter repayment term or make extra payments to pay off the debt faster.

Other factors that affect student loan refinancing eligibility

Private lenders consider several different factors to determine your eligibility to qualify for student loan refinancing, including your:

• Credit score

• Credit history

• Other debt

• Income

• Graduation status

Before you apply with a lender, go through the pre-qualification process with multiple lenders to gauge your approval odds and get some rate quotes that you can compare. This process involves a soft credit check, which won't impact your credit score, and can give you the information you need to determine whether refinancing is the right move for you.