How Does Student Loan Interest Work?

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Saving money on student loans starts with understanding their interest rates. So, what is student loan interest, and why do their rates matter?

Loan interest is the cost of borrowing money. The interest rates vary depending on the loan terms. Understanding the rates can help you understand how much money you will spend to borrow money. Loan interest accrues as soon as you receive the funds.

To better understand, let’s look at a rough example. If you borrow $25,000 with a ten-year loan term at a 5% interest rate, you will pay approximately $6,819.66 in interest for a total of $31,819.66 for borrowing money to pay for school. This means 21% of your payments are interest payments. This example demonstrates a fixed interest rate during the loan term period. Variable rates fluctuate, and the amount of interest you owe will fluctuate, also.

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What Is Student Loan Interest?

Interest is money paid to a lender as part of the cost of borrowing money. Interest is most commonly expressed as an annual percentage of the loan amount. When you borrow money, you must repay the initial amount (the principal) to your lender plus the loan's interest as a way to pay for borrowing funds.

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How Is Interest Calculated on a Student Loan?

Your lender determines student loan interest rates. Students are typically considered risky candidates for private student loans because they lack credit histories and steady incomes. Because of this, the interest rate can be much higher than if a student has an established credit score and career.

Federal student loans have fixed interest rates. This means the interest rate remains unchanged for its lifetime. Private student loans, typically funded by banks, can have either variable or fixed interest rates. Variable interest rates fluctuate during the lifetime of the loan.

For more information on federal student loans and interest rates, browse the Federal Student Aid's Interest Rates and Fees for Federal Student Loans.

Now that you know how interest is calculated, read about how student loan payments are calculated!

Is Student Loan Interest Annually or Monthly?

Even though student loan rates are expressed as annual rates, interest is typically compounded daily. If your loan interest is compounded daily, unpaid interest will be added to your principal balance each day which means the interest rate applies to the new principal balance.

When Do Student Loans Start Accruing Interest?

Many student loans do not require payments while you are enrolled in school. However, these student loans will begin accruing interest despite your enrollment. Federal student loans accrue interest while in school as soon as the loan is disbursed.

Interest does not accrue on subsidized loans while enrolled at least half-time or during deferment periods. The amount of accrued interest on an unsubsidized federal student loan while you are still in school will not be added to your principal balance until after graduation or upon a student status change (e.g., less than half-time enrollment). The federal government pays the interest on federal subsidized loans while you're a student enrolled at least half-time, during loan deferment, and during the six-month grace period following graduation.

Contrarily, unsubsidized loans accrue interest from the time they are disbursed until paid in full. Unlike direct subsidized loans, you are responsible for all interest charges on unsubsidized loans.

Like federal student loans, private student loans accrue interest when you receive the loan. The terms you receive on private student loans will depend on private lenders, and the interest rates can be variable interest rates or fixed interest rates. Most private student loans require you to begin making monthly payments while in school, while others may allow you to defer while enrolled.

How Hard Is It to Pay Off Student Loans?

No one likes paying off student loans. That monthly payment can be a strain on your budget. Because you're paying interest, student loan payments can seem never-ending. According to financial experts, the ideal time frame for repaying student loan debt is ten years; however, in practice, it's more like twenty years. On average, a student borrower takes roughly 20 years to pay off their student loan debt.

The best thing to do is pay more than the minimum monthly payment to get ahead of your student loans and to pay them off faster.

Private Student Loans vs. Federal Student Loans

Regardless of the loan type you choose, you will have to pay it back plus interest. Private loans are made by private student loan lenders such as banks and state-based organizations, and the lender sets the terms and conditions. Federal student loans are made by the government under law, with terms and conditions that include many benefits not typically available with private loans.

There are three types of federal loans:

Direct subsidized federal loans

Direct unsubsidized loans

Direct PLUS loans: Parent PLUS loans and Grad PLUS loans

Federal student loans can be consolidated into Direct Consolidation loans. If you're having trouble making your federal student loan payments, you can temporarily postpone or lower your payments. With federal loans, there are several repayment options to choose from.

Private student loans can have variable or fixed interest rates that may be higher or lower than federal loan rates depending on your situation. A private loan with a fixed interest rate is one in which the interest rate does not fluctuate during the loan's fixed rate period. There are no Direct Consolidation Loans for private student loans, but they can be refinanced. Repayment options will vary with each lender, including repayment penalties.

Frequently Asked Questions About Student Loan Interest

You may have additional questions about student loan interest or how can help you. Below you will find answers to some of the most frequently asked questions about student loan interest.

Will student loans hurt my credit score?

Having a student loan will affect your credit score. Your outstanding balance and student loan payment history will be on your credit report. If you make your payments on time, it can help boost your credit score; on the contrary, if you fail to make monthly payments on time, then you can hurt your credit score.

Do student loans go away after seven years?

Negative information about your student loans may be removed from your credit reports after seven years; however, the student loans themselves will remain on your credit report until they are paid in full.

What happens if you don't make your student loan payments?

If you fail to make your student loan payment or pay it late, your loan can reach default status. If you default on your student loan, it will show up on your credit report and may harm your ability to borrow in the future.

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