How to Calculate Student Loan Interest
Student loan payments can sometimes be confusing and a lot of people are left asking just how much interest will I pay on my student loan?
It's actually a lot easier than you think to calculate your student loan interest payments, and once you do, you’ll have a much clearer idea of what you’re really paying and can better plan your finances.
What is an interest rate
The interest rate is a percentage of the total amount of money you have borrowed charged as an additional payment on top of your loan. It’s paid to a lender to cover the costs associated with borrowing that money.
Unlike other forms of debt you might accumulate throughout your life, such as credit cards or mortgages, your student loan interest accumulates daily as opposed to monthly. Interest rates on federal loans tend to be fixed, whilst private loans could have variable rates meaning your payments could change.
How to calculate
We’ll look at how to find interest paid on student loans, including daily, monthly and annually.
For this example, let's say your remaining loan balance is $15,000 and your annual interest rate is 6%:
Step 1 - Calculate your daily interest rate
This is sometimes known as the interest rate factor and will tell you how much interest you’re building up every day.
First, divide the annual interest rate by the number of days in the year as follows:
0.06/365 = 0.00016 or 0.016%
Step 2 - Calculate how much you’ll be charged each day
Simply take the interest rate factor we calculated in step one and multiply it by the outstanding balance on your loan:
0.00016 x 15,000 = 2.4
This means that for each day you continue to owe $15,000, you’ll be paying $2.40 per day in interest costs.
Step 3 - Calculate your monthly and annual interest charge
Finally, all you have to do to convert this to a monthly cost is multiply the daily cost amount by the number of days since your last payment. As payments are made monthly this will usually be 30 days:
30 x $2.40 = $72
As you can see, interest charges can quickly mount up and you’d be paying $864 in interest per year using the above example.
How are Student Loan Payments Collected?
- Payments are usually made monthly
- Any outstanding fees are deducted first e.g. any previous late payment fees
- Outstanding interest is then deducted
- The remainder of the payment then reduces the loan principal
So if we assume you pay $200 per month, and using the above example, you would spend $72 per month on interest and $128 on the principal.
When do I start accruing interest?
Interest usually starts to accrue daily as soon as your loan is disbursed, so when the cash first lands in your bank account.
This means for most of us that interest will start accruing while you’re still studying.
However, if you have a subsidized federal loan, borrowers have a grace period, usually six months, where the government will pay any interest that accrues.
If you don’t pay the accrued interest whilst in school, the charges will be capitalized and added to the principal of your loan.
Compound Interest and Capitalization Can Increase Your Payments
There are a number of scenarios to watch out for that can end up capitalizing your interest costs and hiking up your loan payments.
Try and avoid these situations where possible as you’ll essentially be paying interest on top of interest, compounding your payments:
Federal student loans:
- At the end of a grace period on an unsubsidized loan - If you don’t pay interest charges whilst at school, these will be capitalized and added to your principal loan
- Failure to keep up with payments - Not only could this result in late payment charges, but the unpaid interest will also be capitalized
- Following a period of forbearance - If you halt payments for a period of time, all interest you would have paid is instead capitalized
- When you no longer qualify on income-based payments - This will be the case when your earnings no longer fit the threshold to qualify. This will also be the case if you voluntarily leave the scheme
- Following a deferment period - This applies to unsubsidized loans
Private student loans:
- Some private loans apply daily compound interest - Some banks apply interest on top of the interest you’ve already accrued the previous day. Check with your provider to confirm what type of interest you’re paying
- After a period of forbearance, deferment or missed payments - These rules are much the same as for federal loans
Knowing exactly how much interest you’re paying each month on your student loan is a simple process.
More importantly, though, it can help you better plan financially and make sure you don’t fall into the capitalization trap and end up paying more than you have to.
It’s always worth considering making overpayments to your principal too in order to keep those interest costs down.
If you’re ever having trouble with your repayments, or feel you could get a better interest rate, don’t hesitate to contact your loan provider to discuss options.