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.

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