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Student Loan Interest Rates – What should you know?

  Sanjiv Gupta CPA  Published 
Student Loan Interest Rates – What should you know?

The interest rate is what students pay after they have borrowed money. It’s pretty much straightforward but for some reason when the topic of student loan and interest rates are being discussed, it tends to be complicated. Here’s a breakdown.

What is Federal Student Loan Interest Rates?

 These are the loans that the individuals apply for after they have filed FAFSA or what is also called the Free Application for Federal Student Aid. It is the federal government that issues these kinds of loans but they are actually serviced and offered by private companies, which include Great Lakes, Nelnet, Navient, and FedLoan Servicing.

Congress manages to set the Rates for Federal Student Loan Interest every year depends on the financial market. This is exempt from federal Perkins Loans which has an interest rate of 5%. These rates also depend on the type of loan and not on the credit score or the individual’s ability to pay the loan back. Federal student loans also have interest rates that are fixed. This means that the rate will not change throughout the loan.

The kind of interest that the individual pays on federal loans also depends on whether these loans are either unsubsidized or subsidized. The government also pays interest on loans that are subsidized while the individual is still in school. The interest also accrues on the calculated unsubsidized loans while the individual is in college. This is also capitalized and then added to the principal amount which was what originally borrowed. This is all done toward the end of the borrower’s grace period.

Private Student Loan Interest Rates

 These are issued by the lenders which include Wells Fargo, Sallie Mae, Discover and the growing crop of online and small lenders. These also have the flexible options of repayment rather than resorting to federal loans. NerdWallet also recommends removing the private student loan once the borrower has already exhausted the options on the federal student loan.

The rates for this kind of loan are between 3% and 13%. It really depends on the term length, lender, kind of interest rate (whether it is fixed or variable) and the co-signers or the borrower’s credit. Generally, the more and better the credit, the lower the interest rate is.

Lenders also look into the debt-to-income ratio as well as the expenses which include credit card debt, car loans, housing costs, which are also relative to income. Typically, the lower the debt-to-income ratio is, the more likely they are to be qualified and eligible for the interest rates at its lowest rate. Individuals are advised to also compare the offers that they can get from a number of lenders in order for them to come up with the interest rate at its lowest possible.

Fixed vs Variable Interest Rates

 Fixed rates remain the same although the duration of the loan whereas interest rates that are variable also change when the market changes. There are private lenders that also offer this kind of interest rate but there are more that also provide variable as well as fixed interest rates. Federal student loans also have rates that are fixed.

On the other hand, variable rates are also typically tied to the Libor or London Interbank Offered Rate’s prime rate. This is the international standard when it comes to calculating the interest rates. There are lenders that are also adjusted to the variable rates for every three months that usually depict the market conditions. It is important to note that there are rates that also change per month.

Meanwhile, variable rates and interest usually start lower than the interest rates that have been fixed. These are also riskier for individuals especially before this actually happens. If they are considering variable-rate loans, then it is also important that they ask how the lender can adjust the rates and how they will be notified when this actually happens. Most importantly, they can also check if there is a cap on this usual rate. Once they choose the loan that is of a variable rate, then they can minimize the risk simply by paying it off as soon as they can.

The interest in these rates is completely unavoidable. In order to save more from this interest, borrowers are advised to pay monthly than the usual minimum. They should also pay the interest off, especially when it accrues even before the end of the grace period. This is to prevent capitalization and also allows the borrower to pay the loan instantaneously.

Refinancing Student Loans

 Student loan consolidation or refinancing are the usual ways for individuals to change the interest rate of a student loan. Once the refinance, they can also take out the new loan especially with interest rates that are lower in order for them to finally repay the student loans that are still existing.

It is also possible to refinance private and federal student loans. However, this can only be done with the assistance of private lenders. Once the individual finishes refinancing federal student loans, then they eventually become private student loans. There are certain features for federal student loans that can be lost in the process. This includes the ability of the individual to register for income-driven repayment plans. This also defers the individual’s loans when they go back to school or when they lose their job.

If the individual keeps the federal protections and make single monthly payments, then they can consolidate their federal student loans with the assistance of the government. This option, the new rates of interest will eventually have the weighted average of the federal student loan and its interest rates.

Understanding individual student loan payments

 The interest is calculated in the form of a percentage of the loan principal. It also accrues on a daily basis. Loans are then no longer terms when they accrue in more interest over a period of time. In order to save the most when it comes to interest throughout the entirety of the loan’s lifespan. Individuals are then encouraged to pay the loan as quickly as they can.

When the individual starts making payments on student loans, then the larger percentage of the payment also goes toward the interest. The smaller portion is then directed to the principal. As the individual continues making payments, then the percentage is flipped. Toward the end of the duration of the loan term, the interest is then paid off. When this happens, a high percentage of the payment is then applied to the principal. The concept is then regarded as the amortization schedule.

If the individual is making small monthly payments, there are some borrowers that pay this through income-driven repayment plans. It is also possible that the monthly payments will also go toward the interest without it chipping away at the principal. They just have to make more than the payment at its minimum per month in order to pay the interest and also make it faster for the principal.

If the individual is also struggling to make more payments on the federal student loan, then he or she can temporarily postpone the payments through forbearance or deferment. These federal subsidized direct loans, as well as its Perkins loans, also do not accrue the interest, especially during the deferment. The other federal loans that do not accrue interest especially during deferment along with federal loans also include the Perkins loans and subsidized direct loans. These then accrue the interest especially during forbearance of the loan.

There are private student lenders that offer forbearance and deferment but there are also others that do not. The policies are usually less generous as opposed to what the federal government does.


 The capitalization of the loan occurs when the accrued interest is eventually added to the loan principal. It also makes the principal amount larger than what was originally borrowed. It also causes the individual to pay higher interest over a period of time because the new interest is then calculated at a percentage that comes with the larger principle.

There are also many scenarios where interest can be capitalized. If there are unsubsidized loans for federal student loans. The interest will then eventually accrue on the loan especially during college when this is added to balance toward the ending of the grace period. The interest is then capitalized toward the end of the forbearance or the deferment. Once the individual has subsidized the Perkins loans or the direct loans, then the interest is capitalized toward the end of the period for forbearance. Capitalization also happens in situations where the individual switches the student loan repayment plans and then default this on a loan and then consolidate the federal student loans.

Student Loan Interest Deduction

 Student loan interest is the amount the individual pays for the extent of the year on the loan that the student is qualified or eligible for. It also includes both a requirement and voluntary payment for the interest payments on a pre-paid basis. The individual can also deduct the $2,500 minimum amount of interest that the individual has paid for that year. The deduction is then reduced gradually and eliminated eventually through a phaseout once the MAGI or the modified adjusted gross income amount reaches that annual limit for the filing status.

The individual then claims the deduction and regards this as an adjustment to the income. There is no need for the individual to itemize these deductions and list these under Itemized Deductions or what is called the Schedule A of Form 1040.

The individual can claim the deduction if all these following scenarios apply:

  • The individual pays interest on the student loan as long as he or she is eligible for that tax year.
  • The individual is legally obligated to pay for the interest on the qualified and eligible student loan.
  • The filing status of the individual is not married and filing separately.
  • The Modified Adjusted Gross Income is lower than the amount that is specified and set on an annual basis.
  • The individual and the individual’s spouse then file jointly can also be claimed as dependents.

The qualified student loan is a particular loan that the individual took out so that the can be qualified for higher education. He or she is qualified for this if:

  • Is a dependent when the loan was taken out.
  • Is borrowing for further education that is provided during that academic period and solely for that qualified student.
  • The debt has been paid and also incurred within that period of time before and after the loan was taken out.

 Here’s Exactly How Student Loan Interest Works

 When new student loans have been issued, then the borrower agrees to a contract and also signs a promissory note that pretty much explains the whole terms and agreement of the loan. Each part of the document is very important to be read and understood especially when it is needed to determine how much is owed and when exactly the payments are due.

The most important terms in this scenario are:

  • Issue date. The day when the loan starts to accrue and accumulate interest.
  • Amount borrowed. The over-all amount that the individual has borrowed for that loan.
  • How Interest accrues. This depends on whether the interest is charged on a monthly or daily basis
  • First payment date. When the individual has to make their first loan payment
  • Payment schedule. This pertains to the number of payments that the individual has to make

Lenders understand that the majority of full-time students cannot have an income. If they do have income, it is only enough to cover the student loans and payments that they have to make while they are in school. Because of this, a number of student loans are then subsidized and checked by the federal government. This also means that they accrue interest while they are still in school.

This is extremely important because it determines whether the loans are unsubsidized and subsidized and also determines whether the balances can also grow while the individual is still in school.