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There's good news for college students and parents who plan to take out loans to help pay for school. Interest rates on federal student loans are dropping for the 2019-2020 academic year, the first decline in two years.

• Undergraduate loan rates will be 4.53 percent, down from 5.04 percent for 2018-2019.
• Parent PLUS loans will be 7.08 percent, down from 7.60 percent.
• Graduate school loans will be 6.08 percent, down from 6.60 percent.

The rates are reset annually and only apply to new loans, not what you've already borrowed. Federal student loan rates are fixed, so they won’t go any higher over the life of the loan. The decline follows a downward trend in interest rates on most consumer loans since the Federal Reserve decided earlier this year to hold rates steady after four increases in 2018.

Still, a half percentage point decline won’t significantly change monthly payments for undergraduates. That’s because the amount they can borrow is limited by the government, from $5,500 to $12,500 depending on what year you are in school and whether or not your parents claim you as a dependent.

For example, a freshman who takes out $5,000 and pays it back over 10 years will save $150 in interest over the life of the loan with the new rates.

“Borrowing is not so cheap that you should overborrow,” says Shannon Vasconcelos, a college finance expert with Bright Horizons College Coach.

More on Paying for College

Nevertheless, the decrease is welcome. As college costs have risen, so has the number of people relying on loans to pay for school. About 65 percent of students who graduated from a four year college say they had to borrow money to cover the cost of college.

The drop could be more meaningful for graduate students and parents who borrow federal Parent PLUS loans, because the amount of those loans isn't capped, says Vasconcelos.

Graduate students and parents can borrow up to the total cost of school. The typical graduate student borrows amounts that pay for half the cost of school, on average $25,000 a year, according to Sallie Mae’s How America Pays for Graduate School report. A graduate student who takes out $50,000 in loans will save $1,500 under the new rates.

Meanwhile, the amount of debt parents are taking on to help their children pay for school is rising even faster than for undergraduate students themselves. Americans age 60 and older are the fastest-growing group of student loan borrowers, primarily because they are taking out loans to help children and grandchildren, according to the Consumer Financial Protection Bureau.

Yet many students and their parents who borrow have little understanding about how their loans work or how a change in interest rates could affect them.

Only about half of students and parents know that they aren't guaranteed to get the same rate on federal loans each year they borrow, according to a 2018 Credible.com student loan quiz. And only 14 percent of parents and students know that Parent PLUS loans have higher rates than undergraduate or graduate loans.

What You Should Know Before You Borrow

Don’t borrow more than you can afford. A good rule of thumb is to limit your borrowing to no more than what you expect to earn annually in the early years of your career. That can help you limit your monthly payments to no more than about 10 to 15 percent of your expected gross income.

So if you borrow $30,000—about average for college graduates—your payments will be about $300 a month. That’s a significant sum but should be doable even if you're making only a modest salary.

If your total student loan debt at graduation is less than your annual starting salary, you should be able to repay your student loans in 10 years or less, says Mark Kantrowitz, publisher and vice president of research at Savingforcollege.com, a website that provides information on 529s and allows you to compare state-sponsored plans.

But if more than 15 percent of your earnings goes to student loan payments, you could struggle to pay and need to cut spending in other areas of your life. 

Of course, it can be difficult to know what your future earnings will be or what career you'll end up in. If you're really unsure, be even more conservative in your borrowing. Look for other ways to lower costs, say, by finding cheaper housing or choosing a less expensive meal plan.

“Don't borrow to the limit. Borrow as little as you need, not as much as you can,” says Kantrowitz.

Be wary of private loans. A private loan rate is typically variable, which means it's likely to rise over time, so you could end up owing a lot more in interest. Federal loans are better if you have to borrow because they have fixed rates and the option of flexible repayment programs. That includes income-based repayment (which can make your loan payments more affordable), deferment if you return to school, or loan forgiveness options if you meet certain conditions.

Unlike private loans, students don’t need a co-signer or credit history to get a federal loan. For parents, taking out federal student loans is also less risky than using home equity or tapping retirement savings to help your kids pay for college.

Keep good records. Once you move into repayment mode, be sure you know what kind of loans you have and which company is servicing them. You will also need to keep records of what you owe and the payments you’ve made.

Save copies of important documents on a flash drive or in paper form. If you have federal loans, you can find the name and contact info for your servicer in this national database. If you have a private student loan, check your credit report to see which firm is listed as a servicer. You can get a free copy of your annual credit report once a year at annualcreditreport.com.

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