If you’ve recently graduated or dropped out of college, you may be surprised at how much of your student loan repayment is spent solely on the interest portion of your debt. To understand why, you must first understand how this interest accrues and how it is applied to each payment.
Key points to remember
Federal loans use a simple interest formula to calculate your finance charges; however, some private loans use compound interest, which increases your interest costs.
Some private student loans have variable interest rates, which means you can pay more or less interest at a later date.
Except subsidized federal loans, interest generally begins to accrue when the loan is disbursed.
3 steps to calculate your student loan interest
Figuring out how lenders charge interest for a given billing cycle is actually quite simple. All you have to do is follow these three steps:
Step 1. Calculate the daily interest rate
You first take your loan’s annual interest rate and divide it by 365 to determine the amount of interest that accrues daily.
Suppose you owe $10,000 on a loan with 5% annual interest. You would divide this rate by 365 (0.05 ÷ 365) to get a daily interest rate of 0.000137.
Step 2. Identify your daily interest charges
You would then multiply your daily interest rate from Step 1 by your outstanding principal of $10,000 (0.000137 x $10,000) to determine the amount of interest you are charged each day. In this case, you are charged interest of $1.37 daily.
Step 3. Convert it to a monthly amount
Finally, you will need to multiply this daily interest amount by the number of days in your billing cycle. In this case, we’ll assume a 30-day cycle, so the amount of interest you would pay for the month is $41.10 ($1.37 x 30). The total for one year would be $493.20.
Interest begins to accrue this way from the time your loan is disbursed, unless you have a subsidized federal loan. In this case, you are only charged interest after the end of your grace period, which lasts six months after you leave school.
With unsubsidized loans, you can choose to pay accrued interest while you are still in school. Otherwise, accrued interest is capitalized or added to capital after graduation.
If you request and get forbearance (essentially a pause in your loan repayments, usually for about 12 months), keep in mind that while your payments may stop while you are in forbearance, interest will continue to accrue. accumulate during this period. and will eventually be added to your capital. If you are suffering economic hardship (which includes being unemployed) and enter deferment, interest will only continue to accrue if you have an unsubsidized or PLUS loan from the government.
Interest on student loans from federal agencies and under the Federal Family Education Loans (FFEL) program was initially suspended until September 30, 2021, through an executive order signed by President Biden on first day of his term. The last extension of the suspension deadline is now January 31, 2022. Borrowers should note that although this is the fifth time the deadline has been extended, the Department of Education has specifically noted that it is would be the last extension.
Simple interest versus compound interest
The calculation above shows how to calculate interest payments based on what is called a simple daily interest formula; this is how the US Department of Education handles federal student loans. With this method, you pay interest as a percentage of the principal balance only.
However, some private loans use compound interest, which means the daily interest is not multiplied by the principal amount at the start of the billing cycle – it is multiplied by the outstanding principal. plus any accrued unpaid interest.
So on Day 2 of the billing cycle, you don’t apply the daily interest rate—0.000137, in our case—to the $10,000 of principal you started the month with. You multiply the daily rate by the principal and the amount of interest accrued the day before: $1.37. This works well for banks because, as you can imagine, they collect more interest when compounding it this way.
The calculator above also assumes fixed interest over the term of the loan, which you would have with a federal loan. However, some private loans come with variable rates, which can go up or down depending on market conditions. To determine your monthly interest payment for a given month, you must use the current rate charged to you on the loan.
Some private loans use compound interest, which means the daily interest rate is multiplied by the original principal for the month plus any unpaid interest charges that have accrued.
While for any other request for funding the private subject is obliged to present some guarantees, a sine qua non for obtaining the money, the student is not obliged to provide any other guarantee than his talent and ability in studying. Therefore, the need to present any proof of income is excluded. The applicant must demonstrate only that he is enrolled at the university and that he has an excellent predisposition to study. For a worker applying for a mortgage it may not even be sufficient to present proof of income received; there are situations in which, due to the request for a large sum or due to certain personal conditions of the applicant, it is necessary to present a guarantor able to provide all the guarantees to the bank. In the case of the honor it is not necessary for a parent or friend to act as guarantor. The spirit of this form of financing is precisely in the possibility that an institution grants an opportunity to the student by trusting in her talent, betting on her future.
Procedures for granting the loan of honor
The question is legitimate: how does the bank assess whether a student enrolling in the first year of university is worthy of a loan? The answer is simple: the graduation mark will be valid. A student with a brilliant academic career, crowned by an excellent final grade, will be able to apply for funding and obtain it successfully, if his course of study has been extremely positive. As for students enrolled in the second year who apply, the institute will evaluate the exams given and the marks obtained during the first year.
Therefore, the first thing a student who intends to access this form of credit must do is consult the web page of the university to which he wants to enroll or to which he is already enrolled, and look for information relating to the scholarships and concessions that the university grants. There are many universities that have established partnerships with banks and institutions in order to offer a chance to the most deserving students. The advice, for those wishing to undertake a university course or a master’s course abroad, is to check on the university website that the university also finances studies outside the national context.
If you have a fixed rate loan, whether through the Federal Direct Lending Program or a private lender, you may notice that your total payment remains unchanged, even if the unpaid principal, and therefore fees of interest, move from one month to the next.
This is because these lenders amortize or spread the payments evenly over the repayment period. As the interest portion of the bill continues to fall, the principal amount you repay each month increases by a corresponding amount. Therefore, the overall bill remains the same.
The government offers several income-based repayment options that are designed to lower payment amounts early on and gradually increase them as your salary increases. At first, you may find that you are not paying enough on your loan to cover the amount of interest accrued during the month. This is called “negative damping”.
With some plans, the government will pay all, or at least some, of the accrued interest that is not covered. However, with the Income Contingent Repayment (ICR) plan, unpaid interest is added to the principal amount each year (although it stops being capitalized when your loan balance is 10% above the principal amount). your original loan).