How it works, where to get the best rate

  • Student loan interest is the cost you pay to borrow money, whether from the government or a private lender.
  • Although the money you pay in interest may seem small at first, it adds up over the life of the loan.
  • Interest on student loans generally begins to accrue as soon as the loan funds are disbursed.
  • Read more stories from Personal Finance Insider.

When borrowing money for college, some students may tend to focus on their total loan balance and let the interest get lost in the fine print. It can be a big mistake. Understanding the interest rate on your loan is a key part of managing debt that you’ll likely be paying off for at least a decade.

What is interest on a student loan?

Simply put, student loan interest is a percentage of your total loan balance, which is basically borrowing costs. The interest rate you receive will vary depending on the type of loan and your lender. The federal government offers three separate flat rates for undergraduate students, graduate and professional students, and parents of undergraduate students. Interest rates vary considerably from one private lender to another.

Although the percentage of money you pay in interest may seem small at first glance, it can really add up over time.

“What a lot of people are going through is that they could pay off their loans for a few years and never reduce the principal,” says Stacey MacPhetres, senior director of education finance at education program provider the EdAssist Solutions workforce. “Usually the reason is that you pay your interest first.”

The good news is that you may be able to deduct up to $2,500 in student loan interest on your federal tax return, depending on your particular situation. You must have less than $85,000 of adjusted adjusted gross income, or $170,000 if you are filing a joint return, to qualify for this deduction.

“Interest on student loans is tax deductible,” says Leslie Tayne, a student loan attorney. “Students will receive federal tax documents from the bank or lender with the amount to be included on your tax return.”

You can read more about IRS tax deduction policies.

How to Calculate Student Loan Interest

How federal lenders and some private lenders determine your interest payments varies. All federal lenders use simple interest, as do many private lenders.

The first payment you make on a


simple interest

the loan covers the interest charges for the month, with the remainder used to reduce the principal amount. Any unpaid interest does not add up from month to month like compound interest.

Here’s how simple interest works, assuming you have a fixed rate loan (a variable rate loan has no regular payments).

Use this calculator to enter the numbers for your personal situation and see how much interest you will pay.

When does interest on student loans begin to accrue?

Generally, interest begins to accrue as soon as your loan funds are disbursed for private student loans and for most federal student loans. The exception is direct subsidized loans, which are interest-free (subsidized by the Ministry of Education) until the start of your repayment period.

However, many borrowers may not be aware that you can pay off the interest while in school and during your six-month grace period to prevent them from capitalizing at the end of that period. Capitalized interest is unpaid interest added to your loan balance after periods of non-payment. This will increase your overall loan balance and you will later pay interest on this higher amount, which will increase the total cost of your loan.

“You could be paying the interest while you’re in school,” says Marguerita Cheng, certified financial planner and CEO of Blue Ocean Wealth. “But I’m here to say that every situation is unique. What I’m saying is if you’re an engineering student and your classes are really tough, maybe you can’t pay the interest and focus on doing well in school. I know sometimes people like absolute advice, and if you can pay the interest, pay it. But every situation is truly unique.

How to get the best interest rate for a student loan?

The best rates you can get on student loans are almost always with federal loans. Plus, you’ll get protections with federal loans that you wouldn’t otherwise get with private loans, like different types of repayment plans and loan forgiveness options.

Keep in mind that you cannot negotiate federal loan interest rates. They are set each year for each borrower, and creditworthiness is not taken into account in the rates. Federal student loans first disbursed on or after July 1, 2021, and before July 1, 2022, are offered at three different rates:

Although federal loans are generally a better option than private loans, you do have the option of shopping around for rates with private loans. For private loans, the better your credit, the lower your rate. If you can’t qualify or are looking to get a better rate, hire a co-signer with great credit.

Will my student loan interest rate change?

The rates for each individual federal rate may change from year to year, but once you have taken out a federal loan, its rate will remain fixed for the life of the loan. Private student loans can have fixed or variable interest rates, which change periodically.

“A lot of people assume they’ll get one interest rate on all their loans,” MacPhetres says. “But you might have one rate for your first year, a different rate for your second year, etc. Understand that these are fixed rate loans, but they can actually change from year to year.”

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