Student loans are a huge financial burden for most borrowers, but the loan balance is not the only serious financial hit. Accumulated interest is also difficult to sustain.
Student loan interest is a major factor in how big your monthly payment will be and how much your loan will be worth until you pay it off. Let’s take a look at how student loan interest works and what you can do to pay off your loan faster and at a lower cost.
What is a student loan?
If you don’t have the money to pay for college, a student loan allows you to borrow money and pay it back later with interest.
College loans are different from grants or scholarships. If you get a grant or scholarship, you are not borrowing that money. It is money that was given to you as a gift and does not need to be paid back.
How does student loan interest work?
When you get a federal or private loan, the borrower will require you to sign a promissory note explaining the terms of the loan. All parts of this document define the amount you need to pay and the due date, so it’s important to read and understand.
You should pay attention to the following:
- Payment Date. The payment date is the day the borrower pays off the loan. In most cases, the payment date is also the point at which interest begins to accrue on the loan.
- Amount borrowed. The loan amount is the amount you borrowed to cover the cost of the loan. If the borrower withholds a charge for expenses, it may be different from the amount you received.
- Interest rate. Your interest rate is displayed as a percentage of the amount you pay to borrow money. Federal student loan rates are determined by Congress based on the amount charged in the bond market. Meanwhile, the interest rate on private loans will vary from lender to lender.
- Fees. You may incur additional fees, such as delinquent fees or expense charges, when you borrow.
- Here’s how interest arises. The loan guarantee statement states whether interest is paid daily or monthly.
- This is how interest is capitalized. The loan agreement details when unpaid interest is capitalized into the principal balance. When interest is capitalized, it is added to the balance. Interest then accrues based on the higher amount.
- First Payment Date. When the first payment is due, a promissory note appears. Depending on the type of loan you use, you may be required to make payments while you are in school, or you may be allowed to defer payments until after graduation.
- Grace Period. Depending on the type of loan you have, you may be able to get a grace period. – After you graduate from high school, you won’t have to pay off your loan. For example, most federal loans have a grace period of six months. However, not all loans have a grace period, so be sure to read the promissory note carefully.
- Payment Schedule. The payment schedule is the number of payments and how often they must be paid. For example, the standard repayment schedule for federal student loans is for 10 years and is paid once a month.
How much can I borrow?
Because you need to pay back the money you borrowed on your college student loan, you only borrow what you need. The amount you can borrow depends on the type of loan. For federal loans, the university determines the amount of money you can borrow, but there are some restrictions.
- Federal Direct Employee Loans are for undergraduate students. Loan limits range from $5,500 to $7,500 per year for dependent students and from $9,500 to $1,500 per year for independent students, depending on the year of enrollment.
- Ending Federal Direct Loan for Employees. The loan limit is up to $20,500 per year for graduate and professional students and up to $40,500 per year for medical students.
- Debt obligations include: The maximum amount you can borrow from a debtor varies. Most lenders will not allow you to borrow more than the cost of enrolling in college minus other financial aid.
- Direct loans are also subject to a general credit limit, which means that there is a maximum total amount you can borrow on an unpaid loan.
The borrowing limit for Federal Direct PLUS loans is the remainder of your college tuition, which is usually not covered by Federal Direct Stafford Loans and other financial aid.
How is interest on a student loan calculated?
All federal student loans have a fixed interest rate, but individual student loans may have a fixed or variable interest rate. When you get a bond, you can decide which bond you want. The type of interest rate can affect the amount you pay and the amount of interest accrued.
Your interest rate is divided by the number of days to get your “interest rate ratio. Then multiply the interest rate factor by the loan balance and then by the number of days after the last payment. As a result, you can see how much interest has accrued during that period. For example:
3.65% (interest rate) / 365 = $0.01 x $1,000 (balance) x 30 days (day after last payment) = $300 in interest will be charged.
How can I lower my student loan interest?
Once you understand how student loan interest works, you can take advantage of that knowledge. There are several ways to lower the overall cost of student loans.
Paying off your loan faster will lower your interest cost. Choose the shortest period you can afford and make extra payments if possible.
Borrowing more money will result in higher interest costs. To keep your student loan balance as low as possible, try to keep your living expenses to a minimum while you are in school.
Choose the student loan option with the lowest interest rate available. If your interest rate is still higher than you want, consider refinancing your student loan at a lower interest rate later.