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- Are student loans compound or simple interest?<\/a><\/li>\n
- How student loan interest works<\/a><\/li>\n
- Why do some student loans have compound interest?<\/a><\/li>\n
- When does student loan interest accrue?<\/a><\/li>\n
- Consider refinancing to save money on interest<\/a><\/li>\n<\/ul>\n
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Are student loans compound or simple interest?<\/h2>\n
The majority of student loans<\/a> \u2014 including all federal student loans and most private student loans \u2014 operate on simple interest. However, some private loans use compound interest.<\/p>\n
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- Simple interest<\/b> is calculated based on the loan amount you originally borrowed.<\/li>\n
- Compound interest<\/b> is calculated based on your loan amount as well as any unpaid interest that has accrued on the loan. Unlike simple interest, compound interest essentially charges you interest on your interest.<\/li>\n<\/ul>\n
Learn More: <\/i><\/b>Average Student Loan Interest Rates<\/i><\/b><\/a><\/p>\n
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How student loan interest works<\/h2>\n
The type of interest \u2014 simple or compound \u2014 affects how your lender will calculate your total student loan interest. Here\u2019s how it works:<\/p>\n
Calculating simple student loan interest<\/h3>\n
Simple student loan interest is calculated using the following formula:<\/p>\n
Principal x Interest rate x Loan term = Simple interest<\/b><\/p>\n
For example:<\/b> Say you have a $15,000 student loan with a 4% interest rate and a five-year repayment term. The simple interest on this loan would be calculated as 15,000 x 0.04 x 5 = $3,000. This means you\u2019d pay $3,000 in simple interest over the life of the loan.<\/p>\nTo see how much your daily interest would be, you\u2019d start by dividing your interest rate by 365 to find your daily interest rate, then multiply this by the principal. In this case, this would look like (0.04 \/ 365) x 15,000, which equates to about $1.64 in daily interest.<\/div><\/div>\n
Calculating compound student loan interest<\/h3>\n
Calculating compound interest is more complicated compared to simple interest. The formula for it looks like this:<\/p>\n
(Principal (1 + Interest rate) Number of compounding periods for a year<\/sup>) – Principal = Compound interest<\/b><\/p>\n
For example: <\/b>Say you have a $20,000 loan with a 5% interest rate and a five-year repayment term. The equation to calculate the compound interest would look like this: (20,000 (1 + 0.05) 5) – 20,000 = 5,525.63<\/p>\nThis is how much you\u2019d pay in compound interest over the life of the loan. Keep in mind that how much you\u2019d pay in interest per year would vary because compound interest takes into account the interest that has already accumulated on the loan.<\/div><\/div>\n
How often the interest compounds \u2014 for example, annually, semiannually, or quarterly \u2014 will also have a major impact on your total interest charges.<\/p>\n
Additionally, with compounding interest, the daily interest will continually be added to your balance and will affect how much you\u2019re charged the following day.<\/p>\n
For example:<\/b> Say you wanted to calculate the daily interest from the above example. To start, you\u2019d first divide your interest rate by 365 to find your daily interest rate \u2014 so 0.05 \/ 365, which equates to about 0.000136. Multiplying this by the principal (0.000136 x 20,000) would then equate to about $2.72 in daily interest at the beginning of your repayment term.<\/p>\nThe next day, this $2.72 would be added to your balance and used to calculate your daily interest.<\/p>\n
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- Day 1:<\/b> 0.000136 x $20,000 = $2.72<\/li>\n
- Day 2:<\/b> 0.000136 x $20,002.72 = $2.7203<\/li>\n
- Day 3:<\/b> 0.000136 x $20,005.44 = $2.7207<\/li>\n<\/ul>\n
Calculating compound interest can be confusing \u2014 but thankfully, you don\u2019t have to be a math expert to find out what your interest costs will look like on a loan with compounding interest.<\/p>\n
Several online compound interest calculators<\/a> are available that can help you easily figure out how compound interest can impact a loan or even a savings account.<\/div><\/div>\n
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Why do some student loans have compound interest?<\/h2>\n
While most student loans charge simple interest, some private student loans come with compound interest that could increase your overall interest costs.<\/p>\n
Additionally, while all federal student loans come with fixed interest rates that will stay the same throughout the life of the loan, private student loans can have fixed or variable rates. A variable rate can fluctuate according to market conditions, which means you could end up paying more or less in the future.<\/p>\n
Keep in mind:<\/b> Even if you have a simple interest loan, compounding could still come into play. For example, if you\u2019re struggling to make payments on federal student loans, you might be eligible for deferment<\/a> or forbearance<\/a> \u2014 two options that let you temporarily postpone your payments.<\/p>\nIf you don\u2019t cover the interest that accrues during this pause, the unpaid interest could be added to your principal loan balance \u2014 this is known as capitalization. This means that interest will be charged on this higher amount going forward, which will increase your overall loan cost. <\/div><\/div>\n
Check Out: <\/i><\/b>Student Loan Deferment vs. Forbearance: How to Choose<\/i><\/b><\/a><\/p>\n
How does interest work for subsidized and unsubsidized loans?<\/h3>\n
If you need to borrow for school, it\u2019s usually best to start with federal Direct Subsidized Loans before turning to federal Direct Unsubsidized Loans and other kinds of student loans. Here\u2019s how these federal student loans work:<\/p>\n
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- Direct Subsidized Loans<\/b> are available to undergraduate students with financial need. The government covers any interest that accrues on these loans while you\u2019re in school at least half time, during your six-month grace period after leaving school, and during any deferment periods. This can help you save money on interest over the life of the loan.<\/li>\n
- Direct Unsubsidized Loans<\/b> are available to undergraduate, graduate, and professional students, regardless of financial need. Unlike with subsidized loans, you\u2019re responsible for all the interest that accrues on unsubsidized loans during all periods. Also keep in mind that if you don\u2019t pay the interest that accrues on an unsubsidized loan while you\u2019re in school, during your grace period, or during deferment periods, it will be capitalized and added to your principal loan balance.<\/li>\n<\/ul>\n
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When does student loan interest accrue?<\/h2>\n
Student loan interest begins accruing as soon as your loan is disbursed by the school \u2014 not just when you have to make payments. If you have a Direct Subsidized Loan, the government will cover this accrued interest while you\u2019re in school.<\/p>\n
But if you have a Direct Unsubsidized Loan or another type of student loan, it could be a good idea to at least make interest payments during deferment periods to keep this interest from capitalizing. Also remember that interest will continue to accrue during forbearance periods, and any unpaid interest will likely be capitalized afterward.<\/p>\n
Keep in mind:<\/b> Due to the COVID-19 pandemic, payments and interest accrual have been paused on federal student loans by the CARES Act. Payments are scheduled to restart after September 1, 2023. <\/div><\/div>\nLearn More: <\/i><\/b>How to Recertify for Income-Driven Repayment<\/i><\/b><\/a><\/p>\n
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Consider refinancing to save money on interest<\/h2>\n
If you\u2019d like to save money on interest, refinancing your student loans could be a good option. Refinancing is the process of paying off your old loans with a new private student loan \u2014 leaving you with just one loan and payment to manage.<\/p>\n
Depending on your credit, refinancing might get you a lower interest rate, which could reduce your overall interest charges and even potentially help you pay off your loans faster.<\/p>\n
Keep in mind:<\/b> While you can refinance both federal and private loans, refinancing federal student loans will cost you access to federal benefits and protections \u2014 such as income-driven repayment plans<\/a> and student loan forgiveness programs.<\/p>\nThis also means you\u2019ll no longer be eligible for the temporary suspension of federal student loan payments and interest accrual provided by the CARES Act. <\/div><\/div>\n
If you decide to refinance your student loans, be sure to shop around and consider as many lenders as possible to find the right loan for your needs. Credible makes this easy \u2014 you can compare your prequalified rates from multiple lenders in two minutes.<\/p>\n\n
- Direct Unsubsidized Loans<\/b> are available to undergraduate, graduate, and professional students, regardless of financial need. Unlike with subsidized loans, you\u2019re responsible for all the interest that accrues on unsubsidized loans during all periods. Also keep in mind that if you don\u2019t pay the interest that accrues on an unsubsidized loan while you\u2019re in school, during your grace period, or during deferment periods, it will be capitalized and added to your principal loan balance.<\/li>\n<\/ul>\n
- Day 2:<\/b> 0.000136 x $20,002.72 = $2.7203<\/li>\n
- Compound interest<\/b> is calculated based on your loan amount as well as any unpaid interest that has accrued on the loan. Unlike simple interest, compound interest essentially charges you interest on your interest.<\/li>\n<\/ul>\n
- How student loan interest works<\/a><\/li>\n
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