On a typical day, banks lend money to customers who want to buy a home, purchase a car, and/or find the best student loan rates. After their doors close, however, banking firms will also borrow money from investors and government entities. In turn, they use those funds for daily operations, to pay back depositors, and continue to issue loans to consumers. The bank makes money when the interest they receive from clients are higher than the rates the firm is paying on its own debts. In the coming years, however, the way that amount is determined might change. So will the current student loan rates.
The upcoming mechanism is known as the Secured Overnight Financing Rate (SOFR). Banks are going to pay an interest rate that is tied to long term government debt. During economic difficulties, financial firms might struggle to find a desirable rate when they borrow money and fund their activities. The SOFR system has its own pros and cons, but any borrower (including students) should prepare for it.
The changes will especially impact those who have a variable rate and enrolled students, alike. Those who prepare are more likely to weather through economic storms without incurring severe financial losses. Just as importantly, taking advantage of the right opportunity enables you to secure the best student loan rates and qualify for new lines of credit in the future.
SOFR and Your Current Student Loan Rates
Whether you have a fixed or variable interest rate, students should prepare for the SOFR adjustment early on. In most cases, tuition loans are due several months after graduation. Those who get their degree during a turbulent economy might end up with an undesirable and relatively high interest rate, even more so when it’s fixed.
In this case, students must have an additional savings account. Otherwise, expensive interest payments can make it hard to transition from college life to starting a professional career. If a savings account is not an option, students who graduate during an economic downturn still have to account for the higher rates. Some may choose to delay completing their degree, while others could take on seasonal summer jobs and grow their savings early on.
Having said that, you might graduate during a strong and booming economic environment. This scenario is certainly more desirable for those who are looking for the best student loan rates. However, to reap the benefits, students should make plans ahead of time.
For example, those with a variable rate can lock in a fixed one when the markets are performing well and interest becomes low. This allows them to avoid the inconsistent and fluctuating floating interest, even more so when the economy underperforms.
Similarly, if the current student loan rates are within your desired range, some students may prefer to graduate early and secure a fixed, low rate.
Other ways to plan for this includes reviewing your credit cards, auto leases, mortgagees, and other budgeting items.
SOFR and Your Plans
Each student has their own aspirations and goals for life after college. In many cases, however, a loan or line of credit may be necessary. For instance, an entrepreneur must get a small business loan to kickstart their endeavors and grow.
Similarly, students who want to buy a home within a few years should revisit these plans. Needless to say, auto financing is also important to both current and former students, especially those who go to college out of state.
Since SOFR impacts almost all loan types, it will likely influence your plans. During a dire economy, interest rates are higher and banks are pickier when they choose borrowers. Therefore, students should understand the credit requirements, debt-to-income limitations, and preferred earnings levels that are associated with their desired loan type. Moreover, determine if your current student loan rates create an obstacle to getting approved.
Otherwise, a bad market can force them to delay their plans. Preparing years or months in advance, on the other hand, dramatically increases a student’s loan approval odds, whether its for a mortgage, car, or business.
SOFR and Your Credit Card
Needless to say, the new and arguably more risky SOFR rules will make banks more selective. Financial institutions are going to take extra steps when they screen applicants. However, this is certainly not the end of the world, especially if you have a strong credit score, to begin with.
In light of this, students should utilize their credit card carefully. Making the right spending choices will be even more crucial after SOFR regulations kick in.
Firstly, your card usage rate shouldn’t exceed 30% of the credit limit. For example, if you have a $200 credit card, don’t spend more than $60. By keeping that number low, your credit score has more than enough time to grow.
Upon graduation, a strong score may be the catalyst behind a successful and enjoyable professional life. Moreover, it allows you to negotiate and secure the best student loan rates, based on your needs and desires. This is regardless of how picky the banks are or where the economy is heading.
Didn’t the Fed Just Cut Rates?
Yes, the Federal Open Market Committee (FOMC) lowered interest rates three times during 2019. There are many benefits to this policy, even more so when used alongside MyFedLoan and other similar resources. For a start, the current student loan rates are directly correlated with the FOMC’s rates. In short, the recent cuts will lower the monthly payments on loans with both a fixed and variable interest.
However, SOFR rules may offset some of these benefits. When banks pay an undesirable rate, they might make it harder to qualify for a loan or line of credit. In other words, banks will minimize their risks by only working with high-income borrowers who have a strong credit score.
Lower interest rates can certainly save you money, but students must always look at the bigger picture. Just as importantly, there are other crucial aspects to SOFR that impact your debt. Many of them are out of our control.
For example, it is almost impossible for someone to rightly predict the next recession or downturn, let alone prevent it. Yet, you certainly have the power to grow your credit score and manage spending.
Getting the Best Student Loan Rates
In the coming few years, a bank’s interest expenses are going to be tied to the Treasury’s bonds. Because SOFR exposes firms to new risks (especially during economic slowdowns), consumers might run into difficulties when they apply for a loan.
Not only does careful planning help students cope with this new environment, but they may even benefit by locking in an interest that is lower than the current student loan rates.
As we head into the holiday period, take the time to review your feature plans, study the interest on your loan, and adjust the budget for the coming semester. Try to define the best student loan rates that suit your goals and objectives.
Some students may have to make sacrifices, such as limiting their credit card spending or withdrawing less money out of the savings account.
Sure, you might not be able to get your family member the expensive Christmas that they want this year. However, if you prepare and plan for SOFR, there will be room for plenty of gifts and shopping sprees in the future. In fact, you may even buy a house sooner than expected.