How Is Student Loan Interest Calculated?

Student loan interest is calculated using a simple formula, but there are a few things that can impact your rate. Here’s everything you need to know about how student loan interest is calculated.

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Introduction

When you take out a loan, whether it’s for your car or your education, you’ll have to pay interest. Student loan interest is the amount of money that you pay to the lender in addition to the amount of money that you borrowed. The interest rate is the percentage of the loan amount that you will pay each year.

For most student loans, the interest rate is a fixed rate, which means it will not change during the life of the loan. The exception is private student loans, which often have variable interest rates that can increase or decrease over time.

The amount of interest that you will ultimately pay on your loan depends on several factors:
-The type of loan that you have (federal or private)
-The repayment plan that you choose
-Whether your interest is subsidized or unsubsidized

How Student Loan Interest Is Calculated

Student loan interest is calculated based on the amount you borrow, the interest rate, and the repayment term. The interest rate is the percentage of the loan that you pay back to the lender in addition to the principal. The repayment term is the amount of time you have to pay back the loan.

Federal Student Loans

The interest rate for federal student loans is set by Congress and changes every year. The rates for the 2018-2019 school year are listed below. These rates apply to new loans first disbursed on or after July 1, 2018 and before July 1, 2019.

-Direct Subsidized Loans and Direct Unsubsidized Loans: 5.05%
-Direct PLUS Loans for Parents and Graduate or Professional Students: 7.60%

Private Student Loans

Interest on private student loans is calculated differently than on federal student loans. Most federal student loans use a simple interest formula to calculate the amount of interest that accrues on your loan. With simple interest, your interest accrues daily and is added to your loan balance at the end of each grace, in-school, deferment, or forbearance period, and at the end of your repayment term. That daily accruing interest gets added to your loan balance and then interest is calculated on that higher balance for the next day. This can cause you to pay more in interest over time.

Factors That Affect Student Loan Interest Rates

There are a few factors that affect how your student loan interest is calculated. The first is the type of loan that you have. Federal loans have a fixed interest rate, while private loans may have either a fixed or variable interest rate. The second factor is the length of your loan term.

Loan Type

The type of loan you have also plays a role in the interest rate you’ll pay. Federal student loans are either subsidized or unsubsidized. Subsidized loans are need-based, and the government pays the interest while you’re in school and during your grace period. For unsubsidized loans, you’re responsible for all the interest that accrues from the time the loan is disbursed until it’s paid off in full. Because subsidized loans don’t accrue interest while you’re in school, these loans typically have lower interest rates.

Federal student loan interest rates for undergraduates are currently 4.53% for subsidized and unsubsidized loans disbursed between July 1, 2019 and June 30, 2020. For graduate students, federal student loan rates are currently 6.08%. These rates are fixed for the life of the loan and do not change annually like private student loan rates.

Loan type also affects how your payments are applied to your balance if you have multiple types of federal student loans from different repayment plans. For example, if you make a $100 payment toward your loans and $50 of that payment is applied to a subsidized Stafford Loan with a 4.53% interest rate and the other $50 is applied to an unsubsidized Stafford Loan with a 6.08% interest rate, more of your payment will go toward reducing the balance on your subsidized loan because it has a lower interest rate.

Loan Repayment Plan

There are several repayment plans available for Federal student loans, and your interest rate may be different depending on the plan you choose.

The Standard Repayment Plan is the default repayment plan for most federal student loans. Under this plan, you’ll pay a fixed amount each month for up to 10 years. Because your payments will be the same every month, you’ll pay off your loan faster and with less interest than with other repayment plans.

The Graduated Repayment Plan is similar to the Standard Repayment Plan, but your payments will start out low and increase every two years. With this plan, you’ll still pay off your loan within 10 years, but your monthly payments will be lower at first, which can be helpful if you’re just starting out in your career.

The Extended Repayment Plan is available for Direct Loans and Federal Family Education Loan (FFEL) Program loans that exceed $30,000. With this plan, you can extend your repayment period to up to 25 years. Your monthly payments will be lower than they would be under the Standard or Graduated Repayment Plans, but you’ll ultimately pay more interest over the life of the loan.

The Income-Based Repayment Plan is available for Direct Loans and FFEL Program loans. Your monthly payment amount is based on your income and family size, and you may have any remaining balance forgiven after 25 years of qualifying payments.

The Income-Contingent Repayment Plan is available for Direct Loans only. Your monthly payment amount is based on your income, family size, and total Direct Loan amount. You’ll have up to 25 years to repay your loan, and any remaining balance may be forgiven after 25 years of qualifying payments.

Loan Consolidation

Loan consolidation is when you combine multiple student loans into a single loan with a new interest rate. The new rate is calculated by taking the weighted average of your current interest rates, rounded up to the nearest one-eighth of 1%.

Conclusion

Assuming you have a fixed interest rate, your monthly student loan payment will stay the same for the life of the loan. But the amount of interest you pay each month will change. That’s because with a fixed interest rate, your monthly payments only cover the principal (the original amount you borrowed). So, at the beginning of your loan repayment period, most of your monthly payment will go towards paying off interest, rather than the principal. But as you pay down your loan balance, more and more of your monthly payment will go towards paying off the principal. And since you’re no longer paying interest on that part of the principal, your total monthly interest payments will decrease.