The Federal Open Market Committee (FOMC) is the monetary policymaking body of the Federal Reserve System and meets at least 8 times a year in order to discuss the current macroeconomic environment in the US and recent financial developments as well as political issues which could systematically impact the economy and the capital markets system. It's called the Open Market Committee because the team of individuals who attend have the power to decide whether or not the Federal Reserve should buy or sell Treasury securities in the open market to reduce interest rates or increase them in order to push the economy in the direction they think will benefit most people, on average. The FOMC recently cut interest rates for the first time in a decade, so it's important to understand the economic implications (if any) for student loan borrowers.
As there are 44 million student loan borrowers in the US who cumulatively owe a loan balance of $1.5 trillion towards student loans, many people may be wondering whether or not and especially how a reduction in the federal funds rate can affect their student loans.
Which rate?
When the Fed lowers or increases interest rates, the Fed changes the range for the federal funds rate. The federal funds rate is essentially the interest rate that is charged to banks for overnight lending, and is currently 2% to 2.25%. While this federal funds rate is not what you'll be paying as the interest rate for the year you take out the federal student loan, it's mostly a benchmark for other loan products such as auto loans and credit card debt as well as mortgages. So if the federal funds rate declines, the rates on mortgages, auto loans and credit cards most likely will also decline, and vice versa.
Federal student loans
Congress determines the interest rates for federal student loans, not the U.S. central bank (the Fed), so if you've taken out federal student loans, you can breathe a sigh of relief, since your interest rate is fixed. It doesn't matter what the FOMC decides to do, you're locked into paying your fixed rate throughout the life of the loan. A rate decrease wouldn't impact your financial situation on your student debt, since Congress meets once a year to determine interest rates for student loans taken out during the upcoming academic calendar. For example, policymakers already met this past spring in order to determine how much the interest rate should be for federal student loans originated between July 1, 2019, and June 30, 2020. Thus, federal student loans that have already been issued won't see any impact from decisions by the Fed.
So while the Fed doesn't directly and immediately influence the rates set for federal student loan interest rates, these rates could potentially move in the same direction as the federal funds rate over larger periods of time. This is mostly due to the fact that Congress makes its decisions for federal rates based on where 10-year U.S. government bond yields are trending, so if the federal funds rate goes down and investors in the capital markets price in a lower long-term yield, federal student loan rates could drop over the next several years.
Variable interest rates
If you have student loans with variable rates, your loans are most likely serviced by a private company. Your variable interest rate is usually a combination of some fixed rate or a spread added to a variable rate (usually LIBOR) so the overall rate becomes variable. LIBOR, or the London Interbank Offered Rate, is the rate that is synced to the federal funds rate, so when the FOMC lowers the fed funds rate, LIBOR will drop accordingly. This means that the lender determines the rate which is calculated based on a complex financial formula that takes into account your income and credit profile.
Due to concerns that the economy could slow down due to tariff wars, the FOMC has started on a path to reduce the benchmark rate. A lower rate means consumers can borrower more cheaply and companies can also take on more debt to finance their operations and to hire more employees. This means that consumption should increase, enough to offset any slowdown due to tariff concerns. Depending on how protective of the economy's run the FOMC decides to be in the next couple of years, rates could remain low.
What next?
The majority of student loan borrowers won't be affected by the Fed's interest rate cut decision due to the fact that most borrowers in the U.S. have federal student loans.
If you have variable interest rates on your student loans do you start paying out less in interest per month, right off the bat? Not necessarily, since it behooves private lenders to keep rates as high as they can before they need to start bringing them down due to competition.
If the Fed decides to push the benchmark rate higher in the future, and you're not comfortable paying a higher rate, you could consolidate your federal student loans or you could refinance your private student loans. Make sure you shop around so you can compare how much money you can save in interest while also utilizing these quick, free and easy methods to automatically reduce your interest rate.
