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After years of being paused amid the COVID-19 pandemic, interest on federal student loans is set to resume in September 2023 and student loan payments will be due again in October. If you’re considering taking out student loans, it’s important to understand the impact of interest on the money you borrow. The interest on federal student loans for undergraduates is 5.5 percent, while the rate on private student loans ranges from just under 4 percent to almost 15 percent.
Knowing how to calculate the student loan interest you’ll pay on student loans will help determine what your student loan payment will look like after graduation. You can also use this information to determine how much extra cash you need to put toward your loans each month to pay them off faster.
To calculate your student loan interest, you’ll need to find out what your daily interest rate will be, multiply that number by your principal or outstanding balance and finally multiply that figure by the days in your billing cycle.
How do you calculate your student loan interest?
Figuring out how much of your student loan payment goes toward interest is fairly simple, especially since most student loans use a simple interest formula. This formula essentially multiplies three factors: your student loan’s daily interest rate, outstanding loan balance and the number of days in your billing cycle.
Most borrowers have federal student loans, which have a fixed interest rate. Private student loans can have either a fixed or variable interest rate. If your loans have a variable interest rate, interest will fluctuate throughout your loan, so you’ll have to readjust your calculations periodically.
Also, some student loans may have compound interest— meaning you’re charged interest on the principal and any unpaid interest. If this is the case with your student loans, you’ll likely have a higher total interest charge.
The example below shows how student loan interest is calculated on a student loan with a standard 10-year repayment term and a fixed interest rate.
1. Find your daily interest rate
To calculate student loan interest, first, divide the annual interest rate on your student loan by the number of days in a year (365). If you borrow $10,000 with 6 percent annual interest, that calculation would look like this:
0.06 (annual interest rate) / 365 (number of days in a year) = 0.000164, or about 0.016 percent in daily interest
2. Determine your daily interest accrual charge
You’ll then multiply your daily interest rate by your outstanding loan balance, or principal balance, of $10,000. This will determine your daily interest accumulation rate.
0.000164 (daily interest rate) x $10,000 (outstanding loan balance) = about $1.64 in daily interest
3. Calculate your monthly payment
For the last step, multiply your daily interest by the number of days in your billing cycle.
Let’s assume that you’re billed on a 30-day cycle. To calculate your monthly payment, you’d make the following calculation:
$1.64 (daily interest) x 30 (number of days in billing cycle) = about $49.20 in total monthly interest
What other factors can affect your student loan interest calculation?
Beyond the interest rate on your loan, a few other factors impact your student loan interest calculations and the amount of interest you will ultimately end up paying. These factors include interest capitalization and amortization.
What is interest capitalization?
There are cases however when paused interest will be added to the principal loan balance you are responsible for paying. When this occurs, it is known as interest capitalization.
In cases where you aren’t on the hook for loan payments until after you leave school, for instance, interest still accrues on your debt while you’re enrolled. This interest capitalization increases your outstanding loan balance, and then interest is charged on the new, larger amount owed.
To avoid interest capitalization, you can start paying your student loans while in college. It’s not required, but it could save you more money in the long run when it comes time to repay those student loans. Some private lenders even discount your interest rate if you choose interest-only payments during school.
What is amortization?
Another factor to remember when calculating the interest you’ll pay on student loans and what your monthly payments will be is that student loans follow an amortization schedule.
Amortization means the amount of interest you pay on your loans each month will decrease over time. A larger portion of your monthly payment will go toward interest in the early months of repayment, but that portion will shrink over time. As the interest portion of each payment decreases, the portion that applies to the principal balance increases, accelerating progress in paying off the loan balance.
Say you have a $10,000 loan on a 10-year repayment plan and an interest rate of 6 percent. A student loan calculator will show you that your monthly payment will be $111.02. In the first month of repayment, $50 will go toward interest and $61.02 toward the principal. In the final month of repayment, however, only $0.55 will go toward interest and $110.47 will go toward the principal.
When does interest start on student loans?
For most student loans, interest starts accruing immediately after loan funds are disbursed. You often don’t have to start making payments until six months after you graduate or drop below half-time enrollment, but any interest that accrues before that will be capitalized or added to your principal balance.
The exception here is Direct Subsidized Loans, a type of federal student loan offered to students who can demonstrate financial need. With this type of loan, the government covers interest charges during school, the grace period and deferment periods. Because of this, interest technically won’t start until you enter repayment after the grace period.
The federal government set interest rates at 0 percent and paused payments on federal student loans more than three years ago in response to the coronavirus pandemic. While the pause remained in effect interest was not accruing on federal student loans.
However, the U.S. Supreme Court blocked the Biden Administration’s plan to forgive up to $20,000 in student loan debt and now millions of student loan borrowers will need to begin repaying loans and interest will be restarted. Interest is scheduled to be resumed Sept. 1, 2023 and student loan payments will begin again in October.
How can you reduce the interest you will owe on student loans?
If you want to reduce the interest you will owe on student loans once payments restart, you can continue making payments during the pause to bring down the principal balance. Now is a great time to take this step while interest has been set to 0 percent, as all your payments will go toward chipping away at the principal.
In addition, by paying down your principal more aggressively during the pause on interest, you may ultimately shorten the repayment timeline for your student loan debt. A reduced repayment timeline, in turn, can minimize the total interest payments you’ll make over the life of the loan.
If you are considering borrowing money for school, the next step is to shop around to find the best student loan for you. Comparing offers and rates is a crucial step before applying for a loan to ensure you get the best terms and interest rate.
You can use a student loan calculator to estimate how long it will take you to pay off your desired loan and to calculate your student loan interest. It’s also always beneficial to speak with a financial advisor about creating a budget that works with your interest rate and loan type, especially if you’re borrowing a private loan.
Frequently asked questions
In the case of federal student loans, interest accrues daily. However, when performing the math to determine how much interest you will ultimately pay, student loan interest is calculated monthly, multiplying your daily interest by the number of days in your monthly billing cycle.
The current interest rate on federal student loans is 5.5 percent for undergraduate direct subsidized and unsubsidized loans. For graduate direct unsubsidized loans the rate is 7.05 percent. For private student loans the rate varies from 4 percent to nearly 15 percent.
Yes, you may deduct from your taxable income the lesser of $2,500 or the amount of interest you paid during a calendar year. However, the deduction is gradually decreased and phased out entirely based on your modified adjusted gross income. Interest is deductible for those whose MAGI is $85,000 or less for single filers and $175,000 or less for those who file jointly.