How Is Interest Calculated on a Federal Student Loan?
Most students know that they loans they draw for school must be paid back at one point or another. Most students also understand that interest rates play a role in the total cost of the loan, and they might also know a little bit about how higher numbers translate into higher costs.
But delving deep into the methods officials use in order to calculate interest on a federal student loan could be helpful for many students, as each and every federal loan has slightly different rates, rules and specifics involved, and each alteration has financial repercussions for the students who utilize these loans.
Interest Rate Basics
Interest rates allow the U.S. Department of Education to generate funds that can be used for future loans. With each payment a prior student makes, a new student might have more funds available to help pay for an education. The interest fees also help to cover administrative costs associated with running this federal program.
According to the website created by the U.S. Department of Education, a daily interest formula dictates the amount a student must pay. By multiplying the outstanding principal balance by the number of days that have passed since the last payment and the interest rate factor, the final interest amount is calculated.
Students might easily understand some of the figures used in this calculation. They might know the exact amount of their loan balance, for example, and they might be aware of the days that have passed since they posted a payment. But the interest rate factor can seem a little complicated. In reality, it’s an easy number to determine. Students must simply divide the loan’s interest rate by the number of days in the calendar year.
Rules to Watch
At one point, student loans followed a simple fixed rate that did not change over time. Much of that changed in 2013, when President Obama signed legislation that tied federal interest rates to the financial market. Now, interest rates might shift up or down each year, depending on the success of that market. According to analysis conducted by The Washington Post, those interest rates are capped at a specific level, so they can’t just rise without hitting a ceiling. But even so, the amount of interest a student pays on a loan taken out in one year might be much different than the interest required on a loan taken out in a different year.
- Direct Subsidized Loans: Interest payments are covered while the student is in school.
- Direct Unsubsidized Loans: Interest charges begin to accrue while the student is in school, although students can defer those interest payments.
- Direct PLUS Loans: Interest begins to accrue when the total loan amount has been disbursed, but students can defer those payments if they’re still in school.
- Perkins Loans: Interest charges don’t begin to accrue until the student has completed a degree program or drops out of school (in most cases).
All of these rules are spelled out in the loan documents students sign, and borrowers should be sure to read the fine print before agreeing to take out any kind of loan for school.