05/24/2015 12:52 pm ET Updated May 24, 2016

Learning More About Your Student Loan Rates Could Save You Thousands

Understanding how student loan rates are determined can help you figure out if you are overpaying on your student loans. Here is a breakdown of how student loan rates are determined and what you can do to fix them.

How Are Federal Student Loan Interest Rates Determined?

Federal student loan interest rates are set by Congress. The government partially determines these rates based on data from the financial markets. Recent legislation tied federal student loan interest rates to the U.S. Treasury 10-year note price. Current loan rates can be found at the federal student aid website.

How Are Private Student Loan Interest Rates Determined?

Similar to car loans or mortgages, private student loans are usually calculated using the “prime rate.” The Wall Street Journal periodically publishes this rate. The prime rate is based on the best interest rate major banks offer to trusted borrowers with excellent credit ratings. Another common rate used is the LIBOR average interbank interest rate.

The actual interest rate on a borrower’s private student loan can be higher than the prime rate for a few reasons, such as:

  • Borrower’s or co-signer’s credit rating
  • Additional fees (see below)
  • Whether or not the interest rate is fixed or variable

Private student loans can also be fixed or variable. Variable rates are currently lower than federal fixed rates but are subject to increases over the life of the loan.

Other Fees That Affect Student Loan Rates

Federal student loan interest rates are fixed and guaranteed by the government. Federal student loans, however, do come with a loan fee. Usually this fee is a percentage, currently around 1 percent for undergraduate loans, which is taken off the total amount dispersed. For graduate loans, this fee is over 4 percent.

Some private student loans may have origination fees, which can be paid in full up front or added to the total loan amount. If added to the full amount, this will usually be reflected in the APR rate. If you are looking to see how private loans compare across lenders, it is important to compare APR rates, as that rate will reflect all fees of the loan, including administrative fees.

What’s the Difference Between Paying Principal vs. Interest?

When you make loan payments, you could be paying off the interest on the loan, the actual amount you still owe (principal), or both. This process is often referred to as amortization. It’s better if some, or all, of your payment goes towards paying down the principal, since this reduces the interest payment. Any prepayment on your student loans will go towards paying down your principal balance.

Can Student Loan Rates Be Adjusted?

If your interest rates on your loans are high and you would like to change your rate, refinancing might be the right option for you. Refinancing allows you to take advantage of current market rates and your improved financial situation after graduation. Lenders target various profiles of creditworthy candidates and have differing underwriting models, so it is important to explore your options with several lenders to see what interest rates may be offered to you. Some refinancing lenders offer rates below 2 percent.

If you think you are overpaying on your student loans or need to take out a private student loan, visit Credible.

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