How to calculate student loan interest on federal and private loans

Learn how to calculate student loan interest on federal and private loans, as well as the factors that affect interest costs. (Shutterstock)

If you need to take out student loans for college, it’s important to know how much that borrowed money will cost you in the end. To figure that out, you’ll need to do some calculations. Knowing your interest rate, principal, and repayment term is a good start. Here’s a look at how to calculate student loan interest on federal and private student loans. 

If you’re looking to refinance your student loans, visit Credible to compare student loan refinance rates from various lenders.

• Two types of student loan interest: Simple vs. compound interest
• How to calculate student loan interest: The basics
• When does interest start to accrue on student loans?
• How student loan payments are applied to principal and interest
• Factors that can make student loan interest snowball
• How to keep student loan interest costs low

Two types of student loan interest: Simple vs. compound interest

When it comes to calculating student loan interest, you need to consider two different types, especially if you have private student loans: simple interest and compound interest.

Federal student loans all accrue simple interest. Despite the name, the calculation for simple interest is a bit complicated. 

Lenders use a daily formula that multiplies your outstanding principal loan balance by your interest rate factor (your interest rate divided by the number of days in the year). That number is then multiplied by the number of days since your last student loan payment. Here’s the calculation:

• Simple daily interest = [Remaining principal balance x interest rate factor] x number of days since last payment

Though all federal loans and most private student loans use a simple interest formula, some private student loans use compound interest. This means lenders add unpaid interest charges to the remaining principal balance. 

The next time lenders calculate interest, they use that new principal balance — meaning that you’re charged interest on your interest. As a result, student loans with compound interest are more expensive to repay than loans with simple interest, when all other variables are the same.

STUDENT LOAN REFINANCING CAN POTENTIALLY SAVE BORROWERS $5K

How to calculate student loan interest: The basics

Determining how much interest your loans will cost you over a specific period of time involves a few important calculations.

To find the daily interest rate, also known as the interest rate factor, divide your loan’s interest rate by the number of days in the year (usually 365). This represents the interest rate applied to your loan each day that you carry a balance. So, if your loan has an APR of 10.99%, your daily rate is calculated this way: 0.1099 / 365 = 0.000301, or 0.0301%.

The daily interest charge is how much your loan will cost you daily, expressed as a dollar amount. To calculate this,  multiply your daily interest rate by your loan’s remaining principal balance. 

So, if you owe $20,000 on the day you calculate your daily interest — and have that same 10.99% APR — your daily interest amount will be about $6: 0.000301 x $20,000 = $6.02.

The monthly interest charge is how much your loan will cost you each month, and this calculation is also simple once you have the other two numbers. Multiply the daily interest charge by the number of days since your last payment.

Let’s say you made a payment on June 1 and your next payment is due on July 1 (30 days later). With that same loan ($20,000 and 10.99% APR), you could expect a monthly interest charge on that statement of about $180. This is what the calculation looks like: [$20,000 x 0.000301 ] x 30 = $180.60 monthly.

Other factors can affect your interest costs too, but this is a good place to start when calculating how much borrowing will cost you. 

When does interest start to accrue on student loans?

All student loans — federal and private — begin accruing interest as soon as the money is disbursed to you or your school. This means your loan will technically begin costing you money even before you graduate and start paying off the debt.

The difference is who’s responsible for paying that interest if you’re still enrolled. 

Federal student loans 

With some federal student loans, the government subsidizes your interest as long as you’re enrolled in classes at least half-time, and for the first six months after you graduate. This means that any interest on the loan won’t be added to your balance until you reduce your course load or reach the end of your grace period after graduation.

Other federal loans are unsubsidized, meaning the government doesn’t pay your interest. Instead, this interest — which also begins accruing at disbursement — is added to your loan balance and is your responsibility. Once you graduate and are past the grace period or unenroll and begin repaying that balance, it’ll include the accrued interest from when you were in school.

Private student loans

Private student loans are also unsubsidized. They begin accruing interest immediately, which is added to your loan balance. When you graduate, you’ll be responsible for the original loan amount and any interest charges that have accrued.

Forbearance and deferment

Federal student loan borrowers may be eligible for forbearance and deferment periods if they’re unable to make loan payments as scheduled. 

With forbearance, interest will continue to accrue, even if you're not required to make payments. With deferment, you may or may not be required to pay the interest that accrues, depending on your loan type (you generally don’t have to pay interest during this time if you have a Direct Subsidized Loan, Subsidized Federal Stafford Loan, Federal Perkins Loan, or the subsidized portion of an FFEL Consolidation Loan).

If you don’t pay the interest as it accrues, it may be added to the principal loan balance. This is called capitalization, and it impacts your loan the same way that compound interest does.

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How student loan payments are applied to principal and interest

Student loans typically have a set monthly payment amount for the duration of the repayment period. While your minimum monthly payment typically doesn’t change from one month to the next (unless you have a variable-rate loan), the portion of that payment that’s applied to your principal — versus the portion that goes toward interest — does change.

As long as the loan has a simple interest calculation, the monthly interest charge is calculated for each statement cycle. This determines how much interest is charged on the remaining principal balance for that month, according to the interest rate and the number of days in that cycle.

Your monthly payment first goes toward paying interest charges. Any remaining funds from your monthly payment amount are then applied to your principal balance. This reduces your outstanding balance. Next month, when the same calculation is applied, the amount of interest charged will be slightly lower, meaning that more of your payment will be applied to the principal.

When you first begin repaying your loan, a significant portion of your monthly payment will go toward interest. Over the life of the loan, however, more and more of your monthly payment will go toward your principal. This is called amortization.

Factors that can make student loan interest snowball

Federal student loans typically limit the amount you can borrow. Many private lenders also impose loan limits, depending on your credit score and other personal factors.

So, if the amount you can borrow for college is limited, how do people end up with daunting amounts of student loan debt? This can happen for a few different reasons.

Capitalization

Capitalization occurs when a federal borrower fails to pay the accruing interest on their student loans due to forbearance, deferment, or default. These unpaid interest charges are added to the loan’s principal balance; when lenders calculate future interest charges on the loan, they calculate on both the original principal and the added interest.

Essentially, you’re paying interest on your previous interest charges. This increases the overall loan amount and can lead to balances that grow over time instead of shrinking.

Variable interest rates 

Student loans with a variable interest rate can also cause interest costs to build over time. If rates increase, so will the monthly interest charges, costing you more money. And unless you make a larger monthly payment, less of that minimum payment will go toward the principal balance.

Compound interest 

Compound-interest loans can also result in interest charges that build over time. Any accrued finance charges on a compound-interest loan will be added to the principal balance. The next month, when interest is applied again, it’ll be calculated on the now-increased outstanding balance.

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How to keep student loan interest costs low

You can do a few things to help keep your student loan interest costs as low as possible: 

• Comparison shop for the lowest rate on a private student loan. If you must take out private student loans, finding loans with the lowest possible fixed rate will save you interest every month. If you make the same monthly payment, you’ll also get out of debt sooner with a lower rate than you would paying down a loan with a higher interest rate.
• Make interest payments while still in school. If your student loans aren’t subsidized, you’ll be responsible for any interest that accrues while you’re still in school. Rather than allow your loan balance to grow unchecked, you can choose to make interest payments even before you graduate.
• Consolidate federal student loans. With a Direct Consolidation Loan, you can combine your federal student loans into a single loan. The loan’s interest rate is calculated as an average of the rates from the loans you’re consolidating, and can also switch any variable-rate loans into one fixed-rate loan. That can potentially save you money over the course of your repayment.
• Refinance private student loans. By refinancing your private student loans, you can simplify your repayment and potentially reduce your interest rate in the process. Refinancing can also allow you to release a cosigner from your loans and switch variable-rate loans to a fixed-rate loan.
• Avoid refinancing into a longer-term loan. While it can be tempting to choose a longer loan term when refinancing private student loans (and get a smaller monthly payment), this isn’t usually the most cost-effective option. Instead, this can result in paying more interest over the life of the loan.
• Avoid forbearance. Forbearance can be necessary in some cases if you’re experiencing financial hardship. But any unpaid interest that accrues during this time will capitalize, or be added to the loan’s outstanding balance. This results in greater interest charges in the future, and a higher overall cost for your debt.

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