For the first time in a long time, the US economy is showing signs of inflation. For student loan borrowers, this is a significant development.
Before jumping into the specifics about how inflation impacts student loan borrowers, I want to point out that I don’t know whether or not inflation will become a major issue in the coming years. Top economists don’t know what the future holds.
However, what we do know for sure is that inflation impacts student loan borrowers.
What is inflation?
Inflation is a general rise in price levels in an economy over a period of time.
In most cases, small steady inflation is normal. Most experts say that some inflation is a good thing and a sign of a growing economy.
As consumers, we see the prices of goods and services increase. However, historically, inflation also meant increases in wages.
If there is inflation, it means that a dollar today buys more than a dollar will in the future.
So what does this have to do with student loans?
Inflation is Good for Many Borrowers
Suppose you are repaying your federal loans on the 10-year repayment plan. Each month you pay $324 towards your debt.
If there is steady inflation, those $324 payments will seem more affordable with each passing year. As noted earlier, inflation typically means salary increases, so that same $324 payment will be a smaller portion of your salary.
The borrowers hurt by inflation are the ones with variable interest rates.
The Student Loan Borrowers Hurt by Inflation
Variable-rate loans have interest rates that can go up or down.
During times of higher inflation, borrowers should expect variable-rate loan interest rates to increase.
When borrowers see a larger than expected monthly bill, the culprit is often a variable-rate student loan with a recent rate adjustment.
The borrowers hit hardest will be the ones who do not experience wage growth during inflation, but they do see increased monthly payments.
How do I know if my loan is a fixed or variable rate? Federal student loans are fixed-rate loans. Congress adjusts the interest rates on new loans each year, but once the borrower receives the loan, the rate does not change.
Private student loans should indicate if the interest rate is fixed or variable on the monthly statements. If the answer isn’t obvious from your statement, a quick call to your lender should remove any doubt.
Preventing Inflation Issues
The borrowers most vulnerable to inflation are the ones with variable-rate private student loans.
While some of these loans have interest rate caps, the maximum possible interest rate is often in the 9-10% range.
If you have a variable-rate loan and are concerned about future inflation, the best way to address this issue is to refinance with a fixed-rate loan.
If inflation is around the corner, it hasn’t hit the student loan refinance market yet. Borrowers can still get low interest rates on a 20-year fixed-rate loan.
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