How To Calculate Interest on Student Loans

When you borrow money to pay for school, the interest rate attached to your student loans significantly impacts the total amount you'll pay over time. Interest accrues daily on most student loans from the day the funds are disbursed. If left unpaid, interest can compound and significantly add to the total cost of your debt.

This article breaks down how to calculate interest on your student loans, along with strategies to help you avoid unnecessary debt growth.

How does interest work on student loans?

Interest on federal student loans begins accruing daily from the moment your loan is disbursed. It's typically calculated using a simple interest formula, which applies a fixed percentage to your loan balance.

If you have federal Direct Unsubsidized Loans, you're responsible for paying the interest that accumulates daily while you're in school. Any unpaid interest gets added to your loan's principal balance when full repayment begins, six months after you leave school. If you have Direct Subsidized Loans, the government covers the interest while you're enrolled and during the six-month grace period after you graduate.

Private student loans usually follow the same simple interest model, but some lenders use compound interest. With compound interest, any unpaid interest is added to your loan balance each day. As a result, you'll pay interest on a growing balance, which increases your total interest costs unless you actively pay off the interest as it accrues.

How to calculate your daily interest

Calculating daily interest gives you a clear picture of how much your student loan costs you every day. To find this amount, multiply your loan's outstanding balance by the daily interest rate.

For example, if you have a $10,000 loan with a 5% annual interest rate, divide the interest rate by 365 (the number of days in a year). This gives you a daily rate of about 0.013%. Multiplying this by your loan balance means you're accruing around $1.30 in interest each day.

Higher daily interest charges can make it harder to reduce your loan balance since a larger portion of your monthly payment goes toward interest instead of the principal.

How to calculate simple interest on student loans

Most student loans charge simple interest rather than compound interest, which means interest is calculated only on your outstanding balance. Here's an easy way to calculate your estimated monthly interest costs:

• Find your daily interest rate: To calculate your daily interest rate, divide your loan's annual interest rate by the number of days in a year (365). For example, if you have a 5% annual interest rate, the daily rate would be 0.00013, or 0.013%.
• Calculate daily interest: Multiply your loan balance by the daily interest rate. So, if you have a $10,000 loan, you'd be charged around $1.30 in interest each day.
• Estimate monthly interest: To find out how much interest you're paying each month, multiply your daily interest by the number of days since your last payment. For example, after 30 days, you'd owe around $39 in interest.

For a quicker estimate, you can also use an online tool like Credible's student loan interest calculator to get a clear picture of your total repayment costs, including interest.

Current student loan rates

Understanding compound interest on student loans

While most student loans use simple interest, some private student loan rates may involve compound interest, which works differently.

Instead of just calculating interest on your original balance, it's calculated on the total balance, including any unpaid interest from the previous day. For example, if your loan balance is $10,000 with a daily interest rate of 0.013%, you'll start by accruing $1.30 in interest. The next day, interest is calculated on $10,001.30, so you're paying interest on interest, which increases your costs over time.

Since compound interest builds off of itself, it's generally more expensive than a simple interest loan. Additionally, many private loans may have variable interest rates, which can change based on market conditions. This means your monthly interest charges may vary, depending on the rate you're being charged that month, making it harder to predict your total costs.

Check Out: What Increases Your Total Student Loan Balance?

Tips for managing student loan interest

Student loan interest can add up quickly. If you want to keep interest charges under control, consider implementing the following tips:

• Make interest payments while in school: Interest often accrues while you're still in school. If you pay off the interest as it accrues, you can prevent your overall loan balance from growing and avoid higher costs down the line.
• Make extra payments to reduce interest: When you make extra payments, you can chip away at your principal loan balance. A lower loan balance means you'll face smaller interest charges, which can add up to big savings over the course of your loan term.
• Use the debt avalanche method: If you have multiple loans with different interest rates, prioritize paying off the loan with the highest rate first. This strategy helps you reduce the most expensive debt faster, saving you money on interest.
• Refinance to get a better rate: If you have private loans with high rates, refinancing can potentially help you secure a lower interest rate and make repayment more manageable. But refinancing federal loans usually isn't recommended since you lose access to important borrower protections.

FAQ

How often does interest accrue on student loans?

The interest on federal student loans accrues daily starting from the date the funds are disbursed. For most private student loans, interest also accrues daily.

Can I lower the interest rate on my student loans?

Yes, refinancing could help you lower your student loan rate. However, if you're considering refinancing federal student loans with a private lender, be sure to weigh the pros and cons. Refinancing federal loans means giving up benefits like income-driven repayment plans and loan forgiveness options.

What is the difference between fixed and variable interest rates?

A fixed interest rate remains the same for the life of the loan. Variable interest rates may rise or fall during the life of the loan.

How can I reduce the amount of interest I pay over time?

You can reduce the amount of interest you pay over time by making extra payments to lower your principal balance.

Is student loan interest tax -deductible?

Yes, student loan interest can be tax -deductible. Some taxpayers can deduct up to $2,500 in student loan interest payments.