How Is Student Loan Interest Calculated

Interest on all student loans borrowed under The Educational Department’s programs is calculated on a simple daily basis. The following formula demonstrates how the simple student loan interest is calculated between payments:

Student Loan Interest Calculation Formula

Average daily balance between payments x Interest rate x (Number of days between payments /365.25)

How interest accrues between payments made on June 5 and July 5, for example:

Average daily balance: $10,000
Interest rate: x .08
Days between payments (30/365.25): x .08214
Monthly interest: $65.71

The student loan holder first applies your payment to late charges or collection costs on your account (if any), then to the interest that has accumulated (accrued interest). The remainder of the student loan payment is then applied to the principal balance of the student loan. Just as the accrued interest varies monthly, depending on how many days elapse between the receipt of payments, the amount of a payment applied to accrued interest and the amount applied to principal also will vary monthly. A breakdown of how your student loan payments are applied should be on your billing statement. If you pay online and do not receive a statement, ask your student loan holder or servicer for that information.

A Deeper Look At Understanding Student Loan Interest

Student loan interest is the additional amount you pay on top of the principal amount borrowed, which is charged by the lender for the privilege of borrowing the money. Understanding how student loan interest works is essential for managing your loans effectively. Here’s a breakdown:

Principal Amount:
The principal amount is the initial amount borrowed. For example, if you borrow $10,000 for your education, the principal amount of your loan is $10,000.

Interest Rate:
The interest rate is the percentage of the principal amount charged by the lender. Interest rates can be fixed, meaning they stay the same for the life of the loan, or variable, meaning they can change periodically based on market conditions. The interest rate is a crucial factor in determining the total cost of your loan.

Accrual:
Interest accrues on your student loan daily based on the outstanding balance of the loan. For example, if you have a $10,000 loan with a 5% annual interest rate, the daily interest accrual would be approximately $1.37 ($10,000 x 0.05 / 365 days).

Capitalization:
In some cases, unpaid interest may be capitalized, meaning it’s added to the principal balance of the loan. This can occur when you enter repayment, change repayment plans, or defer payments. Capitalization increases the total amount you owe and can result in higher interest costs over time.

The Types of Student Loan Interest

Subsidized Loans:
For federal subsidized loans, the government pays the interest that accrues while you’re in school at least half-time, during the grace period, and during certain deferment periods. This means you won’t be responsible for paying interest during these periods.
Unsubsidized Loans: For federal unsubsidized loans and private loans, interest accrues from the time the loan is disbursed, and you’re responsible for paying all of the interest that accrues.
Payments: When you make payments on your student loans, they’re typically applied first to any fees, then to accrued interest, and finally to the principal balance. Making payments toward the interest helps reduce the total amount of interest you’ll pay over the life of the loan.

Amortization:
Student loans are typically amortized, meaning your monthly payments are calculated to pay off both the principal balance and the accrued interest over the loan term. Initially, a larger portion of your monthly payment goes toward interest, but over time, more of your payment goes toward reducing the principal balance.

Understanding how student loan interest works can help you make informed decisions about borrowing, repayment strategies, and managing your overall debt. If you have federal loans, you can find information about your interest rates, accrued interest, and repayment options by logging into your account on the Federal Student Aid website or contacting your loan servicer. For private loans, reach out to your lender for specific details about your interest rates and repayment terms.