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As with any loan, federal and private student loans come with interest charges. Federal Direct Loans use a daily simple interest formula, whereas some private student loans may use a compound interest formula.
A simple interest loan calculates interest on your principal balance. A compound interest loan, however, uses a different formula that typically results in higher interest charges than a simple interest formula.
In general, the terms of your student loan agreement will determine how much interest you pay over the life of your loan. Below we highlight how to calculate student loan interest.
Key Points
• Student loan interest starts accruing as soon as the loan is disbursed. It is calculated daily based on the outstanding principal balance and the interest rate of the loan.
• To calculate the daily interest on your student loan, use the formula: (Outstanding Principal Balance × Interest Rate) / 365.
• Interest on private student loans can compound, meaning that interest is added to the principal balance, and future interest is calculated on the new, higher balance.
• The length of your repayment period affects the total interest you will pay.
• Making extra payments, choosing a shorter repayment term, or refinancing your loans can help reduce the total interest you pay.
Step 1: Calculate Daily Interest
A student loan calculator can help you determine how much interest you may pay over the life of your loan. You can also calculate daily interest costs manually if you know your interest rate.
Say you have a $10,000 Federal Direct Unsubsidized Loan balance with a 5.50% fixed interest rate. You can use the following formula to calculate the daily amount of interest that would accrue on your $10,000 remaining loan balance:
(0.055 / 365) X $10,000 = $1.51
You can apply this formula by converting your 5.50% interest rate into a decimal (0.055) and dividing it by 365 days in a year to determine your interest rate factor. Then you multiply your interest rate factor by your $10,000 remaining loan balance. This calculates your daily interest charges as about $1.51.
Recommended: What’s the Average Student Loan Interest Rate?
Step 2: Calculate Daily Costs
Simple interest is charged as a percent of your outstanding principal. In student loan terminology, the interest typically accrues on a daily basis.
Using the above example of a $10,000 federal student loan balance with a 5.50% fixed rate, your lender would charge about $1.51 in daily interest on your $10,000 balance.
This means that every day that you continue to owe $10,000 on a simple interest loan with a 5.50% interest rate, you accrue $1.51 in interest, which is added to the principal amount you owe. In other words, it costs you about $1.51 per day in order to have your $10,000 loan balance still outstanding.
Step Three: Calculate Monthly Costs
Once you know how much you’re paying in interest every day, you can determine how much you’re paying in interest every month.
In order to figure out how much cash you’re shelling out monthly to pay your accruing interest, you multiply your daily interest cost by the amount of days between payments, which is usually 30 days, or one month. Here it is with our example numbers from above:
$1.51 x 30 = $45.30
This $45.30 estimate of student loan interest is the amount that may accrue over the course of a month.
In general, federal and private student loans are amortizing loans. Student loan payments may cover interest charges and some principal, but you’ll typically pay more in interest at the start of your repayment term. A greater portion of your payment may go toward principal as you pay down your loan balance over time.
Simple vs Compound Interest
Student loans from the Federal Direct Loan Program are daily simple interest loans. In addition to Direct Unsubsidized Loans, these loans include:
Some private student loans may charge compound interest, which is typically more costly than simple interest. What is compound interest? It’s when a lender charges interest on interest and principal.
Simple interest is charged as a percent of your outstanding principal, whereas compound interest is charged on your accumulated unpaid interest and principal balance combined. This is typically more costly than simple interest, because compound interest charges interest on the unpaid interest.
If you have private student loans, you can ask your lender whether the finance charges are based on simple interest or compound interest.
Recommended: Do Student Loans Have Simple or Compound Interest?
When Does Interest Start on Student Loans?
Federal and private student loans typically begin accruing interest when they’re disbursed. There are some exceptions, of course, so the exact timing of when student loan interest accrual starts may depend on your loan type.
The difference between private vs. federal student loans is that federal student loans are made, insured, or guaranteed by the federal government under Title IV of the Higher Education Act of 1965. The federal Department of Education does not guarantee private student loans, which typically come from banks, credit unions, fintech companies, and state-based nonprofits.
Private education loans, including refinance student loans, are not eligible for Public Service Loan Forgiveness, Teacher Loan Forgiveness, or federal income-driven repayment (IDR) plans.
Refinancing your student loans with a private lender may reduce your interest rate. You may pay more interest over the life of the loan if you refinance with an extended term.
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What Is Interest Capitalization?
Interest capitalization is when unpaid interest accrues over time and gets added to your principal loan balance. Interest capitalization can occur with federal and private student loans, but the U.S. Department of Education eliminated most instances of federal student loan interest capitalization effective July 2023.
A federal student loan borrower who exits a period of deferment on an unsubsidized loan or who overcomes a partial financial hardship on the Income-Based Repayment (IBR) plan may face capitalized interest. Federal student loan interest capitalization can also occur upon loan consolidation.
Federal student loan borrowers on the IBR plan can consider switching to the Saving on a Valuable Education (SAVE) Plan. The SAVE Plan is the most affordable repayment plan for federal student loans, according to the Department of Education.
Borrowers who earn less than 225% of the federal poverty guideline (or less than $32,805 for a single borrower and $67,500 for a family of four in 2023) don’t have to make any payments under the SAVE Plan. Beginning July 2024, SAVE Plan payment amounts are based on 5% of discretionary income for undergraduate loans, 10% for graduate loans, and a weighted average for borrowers who have both.
What Is Student Loan Amortization?
As mentioned earlier, federal and private student loans are amortizing loans. That means you’ll typically pay more in interest at the start of your repayment term and less toward interest as you pay down your loan balance over time.
There are variable and fixed-rate student loans, but federal student loans issued after July 1, 2006, have a fixed rate. A variable rate can fluctuate with the market, whereas a fixed rate remains the same over the life of the loan. Amortization refers to the amount of principal and interest you pay each time you make a loan payment.
It’s possible for negative amortization to occur, which is when your monthly payment is low enough that it doesn’t cover the interest charges for that month. Negative amortization causes your loan balance to grow.
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The Takeaway
Calculating student loan interest is a crucial step in understanding the true cost of your education and managing your debt effectively. By knowing how interest accrues and compounds, you can make informed decisions about repayment strategies, such as making extra payments or choosing a different repayment plan.
Looking to lower your monthly student loan payment? Refinancing may be one way to do it — by extending your loan term, getting a lower interest rate than what you currently have, or both. (Please note that refinancing federal loans makes them ineligible for federal forgiveness and protections. Also, lengthening your loan term may mean paying more in interest over the life of the loan.) SoFi student loan refinancing offers flexible terms that fit your budget.
FAQ
How does compound interest differ from simple interest on student loans?
Compound interest is charged on both the principal and any unpaid interest, while simple interest is charged only on the principal — making compound interest more costly over time.
What type of interest do private lenders charge?
Many private loans charge simple interest, but some use compound interest, so it’s important to check your loan terms with your lender.
What type of interest do most federal student loans use?
Federal student loans typically use daily simple interest, where interest is calculated only on the current principal — not on unpaid prior interest.
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