How Lenders Decide on Interest Rates for Student Loans
If you have ever gone looking for a student loan you know that the interest rates that are charged on them can vary dramatically. The reason for this that different loan programs and different banks all use their own way of determining what that rate should be. It is important to understand this as well as how these rates are determined so that you can make sure that you are able to get the best possible rate on your student loan.
The first thing that determines what the interest rate on a student loan will be is what kind of loan is it. When you get one from a bank they may be either subsidized or unsubsidized. In the case of subsidized loans the government covers part of the expense by compensating the banks and they are the ones that determine the interest rate. This rate will be the same for all students and will depend for the most part on what the current government policy is. Things start to get a lot more complicated when it comes to unsubsidized student loans.
An unsubsidized student loan is one that is granted by the banks and determining the interest rate is going to be largely up to them. The first thing that they are going to consider is the prime lending rate. This is the rate that the Federal Reserve charges banks to borrow money and it will have an impact on almost all loans. When you hear on the new things like interest rates are going up or the Fed is cutting their rate this is what they are talking about. It is the governments way of telling the banks how much they want them to be charging for loans in order to allow for the monetary policy that the government is currently attempting to follow.
The prime interest rate is not really something that you can do much about when you are taking out the loan since you have to accept whatever it happens to be at the time that you do apply. However you do have to pay attention to it because many student loans have a variable interest rate. That means that as the prime rate changes so does the rate that you pay. This has caught many students out in recent years because the prime rate was so low, when it went up they were surprised by the increase. If interest rates are low at the time that you take out the loan you may want to lock in a fixed interest rate.
The other big factor that will affect student loan interest rates is their credit history, this is where things get problematic. Usually the biggest factor in determining whether somebody qualifies for a loan and the interest rate that they will pay is their credit history. This is how banks assess the risk they are taking by loaning out the money, if you didn't pay off your last loan they will assume that you won't pay this one either. The problem is that most students have no credit history, they also have no job in most cases. By any rationale measure no bank would ever make a student loan since it would be considered a bad risk. However because of the need for student loans most banks will make them. The problem is determining the interest rate that they should charge.
In truth most banks are really just guessing when it comes to determining what interest rate they should be charging on student loans, they really have nothing to base a decision on. Largely it will come down to how badly the banks wants to grant the loans. There are some that do a brisk business with student loans and actively pursue them, they will usually offer the best rates. Other banks really don't want to be involved in them and in most cases will charge very high rates. As a result there are usually huge differences from one bank to the next when it comes to student loans. This is why you have to make sure that you shop around to get the best possible rate. One thing that you can be sure of however is that you will be paying an interest rate that is fairly high regardless of where you get it. Student loans are risky for the banks and that is how they protect themselves, by charging very high interest rates.