If you receive a federal or private student loan, you will be required to repay that loan with interest. Interest is calculated as a percentage of the amount that you borrowed.
It's important to understand who sets your interest rate, how your interest is calculated, and the fees associated with your loan. The longer you take to pay off your loan, the more interest will accrue, increasing the amount you will be required to repay.
Interest rates vary depending on the type of loan and lender, as well as the year the loan was disbursed if it is a FFELP or Direct Loan from the U.S. Department of Education. These details are generally found in the agreement and notifications you received when you took out your student loan.
Who Sets Your Student Loan Interest Rates?
Direct Loans from the U.S. Department of Education
Congress sets interest rates on Direct Loans from the U.S. Department of Education through legislation that ties the rate to financial markets.
Your student loan servicer does not set your student loan interest rate and cannot change it. Plus, all the interest you pay on U.S. Department of Education loans is deposited into the U.S. Treasury.
Interest rates are determined each spring for new Direct Loans being made for the upcoming academic year – July 1 through June 30. Although most federal student loan interest rates are fixed for the life of the loan and will not change, some have a variable interest rate that can change annually.
Loans Through the Federal Family Education Loan Program (FFELP)
Although new FFELP loans are no longer being made (the program was discontinued in 2010), Congress also set the maximum interest rate for these loans – the lender could set a lower rate, but never higher. Interest rates could be fixed for the life of the loan and do not change or may be variable and change annually.
Private Student Loans
Private student loan interest rates are determined by the lender that made the loan and are based on your credit history and your cosigner, if you have one. The interest rate may be variable or fixed for the life of the loan, depending on the contract you signed when you took out the loan.
Your lender may offer certain benefits that can help lower your interest rate. These may include a benefit for consistent on-time payments or a benefit for enrolling in recurring Automatic Pay from your bank account.
When Your Interest Begins to Accrue
Interest on Direct Subsidized and FFELP Subsidized Loans begins to accrue after your six month grace period. Note: Congress temporarily eliminated the grace subsidy for Direct subsidized Stafford loans disbursed on and after July 1, 2012 and before July 1, 2014.
Generally, interest begins to accrue on Direct Unsubsidized, FFELP Unsubsidized, Direct and FFELP PLUS Loans, and Private Loans as soon as the loan is disbursed.
If you accrue interest while you are in school – as with Direct Unsubsidized, FFELP Unsubsidized, Direct and FFELP PLUS Loans, and Private Loans – you will have capitalized interest if it is unpaid. Unpaid accrued interest is added to the principal amount of your loan after you leave school and finish any applicable grace period.
Simply put, there will be interest to be paid on both the principal of the loan and on the interest that has already accumulated.
To minimize the effects of the capitalized interest on the amount you will pay overall, you can pay the interest during college instead of waiting until after graduation. That way, you start with the original principal balance (minus any fees) when you begin repayment.