How a Recession Can Affect Private Student Loan Rates

Even if you have good credit, your private student loan rates will be affected by the larger credit market during a recession. Private student loan rates are usually higher than federal rates, and a recession will affect private rates differently than it will affect federal rates. There are a number of complex factors that will affect interest rates on private student loans, and a few of those factors include liquidity, risk and the national prime interest rate.

Affect of Liquidity on Loan Rates

Liquidity is a term that refers to the amount of cash actually on the market. During a recession, people lose their jobs and businesses fail. When people lose their jobs, they have a harder time paying off their existing loans. Similarly, businesses that fail will not pay off their business loans. Lenders, as a result, do not have as much cash on hand. Many lenders will lose so much money they will become insolvent and will be forced to close themselves. 

Because there are less lenders and less cash, loan rates on the whole will tend to go up. This is because borrowers are competing for fewer loans on the market as a whole. Whenever a product is in low supply and high demand, it tends to cost more. In this case, the loans themselves are the product in low supply and high demand. Lenders also need to make more money on each loan to compensate for the funds they lost when other loans defaulted.  

Affect of Risk on Loan Rates

When the economy is strong, many lenders move forward with very risky loans. The real estate market is a good example. Jumbo loans are common in a bull market; jumbo loans are mortgages above the national limit. Sub-prime loans are also popular in an economic boom; sub-prime loans are issued at an interest rate lower than the national floor. Jumbo loans and sub-prime loans usually default in high numbers during a recession.

As lenders see these risky borrowers default, they begin to change their attitude about risk. Some shareholders may also put pressure on the lenders to pull back from risky activity. As a result, when you seek a student loan, you will have high interest rates if you are considered a high risk borrower. Most students are high risk because they have short credit histories, few assets and no income. 

Affect of Prime Rate on Loan Rates

The Federal Reserve typically lowers the national prime interest rate in a recession to curb inflation. This rate, the interest banks are charged for their borrowing, largely affects how much a bank can charge for its retail loans and still make a profit. A bank can profit off of a cheaper loan as long as the prime rate remains cheap.

Despite the lower national prime interest rate, many student loan lenders will still keep their rates high in a recession. Again, this is partially because they need to make even more money off of the loan to compensate for funds that were lost in the recession. The lower national interest rate does not always succeed in overcoming other market factors to make loans less expensive.



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