Guide to student loan interest rates

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When you take out a student loan, the amount you borrow isn’t the only thing you’ll have to repay. A portion of your monthly payment will also go toward interest, which can significantly affect how expensive your loan is and how long it takes to pay it off.

All lenders use different criteria to determine your student loan interest rate, which is why it’s so important to compare multiple loan offers. Before taking out a student loan, make sure you understand how interest rates work and how they affect your student loan repayment.

What are student loan interest rates?

Interest is one of the costs of borrowing money, and lenders charge it for the privilege of using their money. As you pay back your loan, the interest you pay is compensation for the lender providing you with the credit upfront.

Student loan interest rates are expressed as a percentage of the principal amount of your loan. In general, interest on a student loan compounds monthly, which means that the amount you pay in a given month is based on the remaining loan amount.

Student loan interest rates are relatively low, especially compared to personal loans, credit cards and other short-term debt. However, not all student loans carry the same interest rate, even if they’re from the same lender. Understanding how they work can give you a better idea of how to save money as you borrow funds for school.

Difference between fixed and variable interest

Student loan interest rates come in one of two forms: fixed or variable. As the term suggests, fixed interest rates remain the same for the life of your loan, which means your monthly payment will also stay the same.

With variable interest rates, however, your interest rate can change over time as the current student loan interest rates on the market go up and down.

In general, variable interest rates start out lower than fixed interest rates, making them more attractive. But they could be more expensive in the long run, especially if you have a long repayment term. Also, fixed interest rates provide more certainty, which is worth it if you’re not much of a risk-taker.

That said, if you have a short repayment period and market rates don’t increase too much during the term, a variable interest rate could save you money.

Federal vs. private student loan interest rates

Federal student loan interest rates are set by Congress. The rates are standardized, which means that everyone who qualifies for a loan pays the same interest rate. However, federal student loan interest rates typically change from year to year.

Here’s how federal student loan interest rates have changed in the last five years:

Direct Loans for undergraduate students Direct Loans for graduate/professional students Direct PLUS Loans for parents and graduate/professional students
Interest rates for 2016-17 3.76% 5.31% 6.31%
Interest rates for 2017-18 4.45% 6.00% 7.00%
Interest rates for 2018-19 5.05% 6.60% 7.60%
Interest rates for 2019-20 4.53% 6.08% 7.08%
Interest rates for 2020-21 2.75% 4.30% 5.30%

Note: New rates take effect July 1 of each year.

Unlike the federal government, private lenders use what’s called risk-based pricing to determine student loan interest rates. This means that if you qualify, your interest rate will be determined by factors like your credit score and history, income, other debt payments and more. As of Sept. 23, 2020, rates from top lenders range from 3.53 percent to 14.5 percent.

Unfortunately, it’s hard to qualify for the lowest rates, especially if you’re a student with a limited credit history, little or no income and no co-signer. These loans also carry more risk than federal loans because they don’t provide protections like access to income-driven repayment (IDR) plans, generous forbearance and deferment options or student loan forgiveness programs.

What factors into your student loan interest rate?

The factors that go into your student loan rates will depend on the type of student loan you get. With federal loans, for instance, the two primary factors are the type of loan you apply for and when the loan is disbursed.

With private student loans, however, a lot of factors go into that decision, including:

  • The lender: Each lender has its own criteria for calculating risk and determining how much to charge.
  • Market interest rate trends: Lenders may use the London Interbank Offered Rate (LIBOR) or prime rate to help determine their interest rates.
  • Your credit score and credit history: Your credit score provides a snapshot of your overall credit health, but lenders will also review your credit reports to determine how you’ve managed your debts in the past. Good management can help you score a lower interest rate.
  • Your annual income: It’s important for lenders to understand whether you can afford to make your monthly payments. They’ll use your gross monthly income to get an idea of your ability to pay.
  • Your other debt payments: Lenders will use your gross monthly income and your other monthly debt payments to calculate your debt-to-income ratio. The higher the ratio, the higher your chances of getting overwhelmed and missing a payment.
  • The loan term: A long repayment term can represent a higher risk to lenders because it gives you more time to potentially miss a payment, and it also increases the odds that the lender will miss out on higher interest rates on new loans. As a result, picking a shorter repayment term could help you score a lower interest rate.

It’s also important to keep in mind that the length of time you take to repay your loan also makes a big impact on how much interest you’ll pay in total. For example, if you choose a 20-year repayment plan over a 10-year plan, your interest rate won’t necessarily go up, but the amount of time that interest rate applies to your balance grows, and you’ll end up paying more money overall.

How to calculate student loan interest

Calculating interest on your student loans can help you determine how much your loans will cost you and also give you an idea of how much you could save by paying more each month. If you want to save some time, use an online calculator to do the math.

If you want to do it on your own, the process requires just three steps:

  1. Find your daily interest rate: Take your interest rate and divide it by 365. If your rate is 2.75 percent, your daily rate would be 0.007534 percent.
  2. Calculate your daily interest accrual: Multiply your daily interest rate by your current loan balance to get your daily accrual charge. With a $15,000 balance, for instance, your daily interest would be $1.13.
  3. Determine your monthly interest charge: Multiply your daily interest accrual by the number of days in your billing cycle. With a 30-day cycle, the monthly charge would be $33.90.

Keep in mind that as your principal balance goes down, so will the amount you pay in interest. Also, note that if you have a variable-rate loan, your interest rate will fluctuate. Finally, if your lender charges compound interest, you’ll pay interest on both the principal loan amount and any unpaid interest that’s accrued, which would increase your monthly payment.

How to save on student loan interest costs

There are a few ways you can work to reduce how much you pay in student loan interest, starting before you even borrow any money and continuing throughout the repayment process:

  • Search for scholarships and grants: The main draw of scholarships and grants is that you don’t have to pay them back. The more money you can get this way to help you pay for school, the less you’ll need to borrow from the federal government or private lenders. Make sure you fill out the Free Application for Federal Student Aid (FAFSA) every year, and devote an hour or two every week to finding and applying for private grants and scholarships on websites like Scholarships.com and Fastweb.
  • Apply for a job: If your class schedule permits it, look for opportunities to work so you can earn money to help pay for college expenses. You may also consider starting a side hustle, which may give you some more flexibility to work around your schedule.
  • Add extra payments after graduation: Once you’ve started your career, create a budget to understand where your money is going and look for ways you can make more room to add extra cash to your monthly payments.
  • Set up automatic payments: Many student loan servicers and lenders offer an interest rate discount if you set up autopay on your account. The discount is generally small, but it’ll still provide savings. Some private lenders may also offer loyalty discounts if you have other accounts with them, which could add even more savings.
  • Refinance your student loans: Refinancing your student loans involves replacing them with one new loan from a private lender. Depending on your income and credit profile, you could qualify for a lower rate than what your existing loans offer. Not everyone qualifies, though, and if you refinance federal loans, you’ll lose out on access to IDR plans and loan forgiveness. Also, private lenders typically aren’t as generous with their forbearance and deferment programs.

No matter how you do it, it’s important to be proactive about reducing your need for student loans and lowering the amount you end up paying in interest.

The bottom line

Interest rates can make it even harder to pay off student loan debt, but the more you understand about how they work, the less of a surprise it’ll be when it comes time to make payments. Take steps now to shop around for the lowest student loan interest rates and set up a plan for repayment; using a student loan calculator can help you determine how different interest rates will affect your repayment.

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