The interest rates on student loans are one of the more complicated parts of student loans. Among the questions that come up is how the interest rates are determined, how the payments are split up between the principal and interest, and how interest actually accrues. Let’s review how this works so you have a good grasp of the terms.
To understand this, you need to know the main terms that are used in student loans. These include the following:
- Interest – This is what it costs you to borrow money on any type of loan (car, mortgage, etc.)
- Principal – The amount that you are borrowing
- Interest rate – It’s calculated as a percentage of the principal
- Fixed-rate – The interest rate stays the same over the life of the loan
- Variable-rate – The interest rate may fluctuate over the life of the loan
Interest Rates on Federal Student Loans
The first thing that you should know about federal student loan interest rates are that they are computed using a fixed-rate. The interest rate is determined for each upcoming school year by Congress.
Interest rates on federal student loans are calculated using a simple daily interest formula. To calculate how much interest you will pay during a year, you can use the following calculation: Principal X Interest Rate/365
Let’s look at an example: If you borrow $4,000 at a 5 percent interest rate, your formula looks like this: $4,000 X 5 percent/ 365 = 0.54 cents a day
Interest Rates on Private Student Loans
Private student loans that are offered by lenders such as Discover and Wells Fargo can be more complicated to determine the interest you will pay. Many lenders will offer both the option of a fixed or variable interest rate.
Depending on your lender, the interest applied to your loan can be simple interest or compound interest formula. Since these loans are based on your credit history, your interest rate can also vary from lender to lender.
Here’s an example of what it could cost you for a private student loan using the same example above using a compound interest formula.
To find the daily interest rate, we divide the interest rate by the number of days: .05/365 = 0.00014 or 0.014 percent.
The interest accrual each day is found by taking the loan balance and multiplying it by the daily interest rate: $4,000 X 0.00014 = $5.80
To find the monthly interest accrued, you take this daily interest and multiply it by the number of days since the last payment: $5.80 X 30 =$174, this is the amount of interest you will accumulate each month until payments begin.
How Loan Terms Affect your Student Loan Interest Payments
Your student loan interest rate is just one of the factors that determine the amount of money you will owe for federal and private loans. The term of your loan will also make an impact. The longer you have to repay your loan, the lower your monthly payments will be. But that also means you will pay much more interest over the life of the loan.
How to Lower your Student Loan Interest Rate
After graduating and you have a stable job, you might consider refinancing your student loan. This may lower your student loan interest rate and in doing so could even lower your monthly payments. However, there are some drawbacks that will need to be considered. For example, you won’t be able to take advantage of Income-Driven Repayment plans or loan forgiveness if you refinance your federal loans. Borrower protections like being able to defer your loan payments could also be lost.
Do you need help figuring out the best option to lower your student loan interest or have other questions about your student loans? Student Loan Medix is here for you with a free, no-obligation consultation. Call us today at (480) 676-2889. You can also email Student Loan Attorney Gary Nitzkin at [email protected] for more information.