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How do lenders decide on my student loan interest rate?

There are many factors that go into determining a student loan interest rate. Some are based on the borrowers but others are not.

Written By: Michael P. Lux, Esq.

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Lender formulas on student loan interest rates are closely guarded secrets.

Whenever a lender offers a student loan they are doing it with the goal of being competitive and making a profit. Today we will peel back the curtain on how these calculations are made and look at ways to ensure you are getting the lowest interest rate possible.

Factors that Affect Private Lender Interest Rates

Credit Score and Income – Many student loan borrowers think that credit score and income are the only factors in determining an interest rate. While these two factors are perhaps the most important, they are far from the only ones.

Debt-to-Income Ratio – A borrower’s debt-to-income ratio is another critical component in the evaluation process. This factor looks at monthly debt and compares it to monthly income. Monthly bills such as a cell phone bill, utilities, and Netflix are not usually included. However, debt on your credit report, such as a car loan, credit card debt, or a mortgage is included. We have previously looked at debt-to-income ratios in more detail.

The Economy – Economic conditions can have a major impact on student loan interest rates. If the government is lending money to banks at low interest rates, it means the banks and lenders are able to pass on some of that savings to borrowers. Additionally, when the economy is doing really well, the need for student loans drops. As a result, lenders have to keep rates low to compete for borrowers.

Co-SignersWe don’t recommend co-signing student loans for school or for refinancing, but the presence of a co-signer can have a huge impact on getting approved and the interest rate offered. Some lenders just want to see a credit-worthy co-signer on the loan while others will adjust rates depending upon the co-signers credit score and income.

Lender Cashflow – Many of the student loan refinance companies are relatively new startups. A newer company is often dependent upon outside money to fund its business as it grows. When these lenders have an influx of new investor money it means they are able to offer more loans at lower interest rates. As the lender’s budget gets tighter, they get pickier about the loans they issue. This factor can also influence the new customer bonus that many lenders offer.

Schools and Area of Study – Not all student debt is equal in the eyes of lenders. For example, student loan companies are far more likely to offer a loan to a doctor with $150,000 of student debt than they are someone who just finished their undergrad. The more graduates from your school and your major make, the more likely you are to get a good rate.

How These Factors Come Together

Almost all lending today is done by computer.

A prospective borrower enters their information, the computer pulls their records, and a decision is made. In order to facilitate this process, all lenders must create an equation for making lending decisions for the computers to use.

The problem for borrowers is that lenders do not share the exact equation that they use in making decisions. They are also constantly updating it. This makes it both an unknown target and a moving target.

In the face of this uncertainty, the only way for borrowers to make sure that they are getting the lowest rate possible is to shop around.

Most loan applications take just a few minutes and have no impact on your credit report. Generally speaking, we suggest checking rates with 3 to 5 of the 16 national refinance lenders. If the offers are relatively consistent, you can feel comfortable knowing you found the best rate. If they are all over the place, it might mean that you have a unique credit profile and it may be worth your time to check with even more lenders to verify you are getting the best deal.

Government Student Loan Interest Rates

The exception to the rule is government loans.

While private lenders don’t share the exact details on their rate calculations, the government is the exact opposite. The interest rates are set by Congress and credit score, income, and major have no impact on the rate you will ultimately pay.

Consolidation of federal loans also follows a simple formula.

The government calculates the weighted average of the loans being consolidated and rounds to the nearest 1/8%. Borrowers who consolidate don’t see any meaningful change in their total interest rate. As a result, consolidation is generally only done to covert existing loans into new loans that are eligible for programs like Public Service Loan Forgiveness.

Bottom Line

Many of the factors that affect student loan interest rates are completely out of a borrower’s control.

Many more, such as major and income, are hard to change overnight.

However, an understanding of these factors can help borrowers who plan ahead to get the best possible interest rate on their student loans.

About the Author

Student loan expert Michael Lux is a licensed attorney and the founder of The Student Loan Sherpa. He has helped borrowers navigate life with student debt since 2013.

Insight from Michael has been featured in US News & World Report, Forbes, The Wall Street Journal, and numerous other online and print publications.

Michael is available for speaking engagements and to respond to press inquiries.

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