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How Does Student Loan Interest Work?

When you take out a student loan, you will not just be paying back the amount you borrowed – the lender will also charge you interest. The easiest way to think of interest is that it’s the cost paid by you to borrow money. Whether you take out a private student loan or a federal student loan, you will be charged interest on your loan until it is repaid in full. So, when you have finished paying off your loan, you will have paid back the original sum you borrowed (your original principal), plus you will have paid a percentage of the amount you owed (interest). Properly understanding the way that student loan interest affects your loan is imperative for you to be able to manage your debt effectively.

 

The Promissory Note

When a student loan is issued, the borrower agrees to the terms of the loan by signing a document called a promissory note. These terms include:

  • Disbursement date: The date the funds are issued to you and interest begins to accrue.
  • Amount borrowed: The total dollar amount borrowed on the loan.
  • Interest rate: How much the loan will cost you.
  • How interest accrues: Interest may be charged on a daily or monthly basis.
  • First payment date: The date when you are expected to make your first loan payment.
  • Payment schedule: When you are required to make payment and how many payments you have to make.

 

How Different Types of Student Loans are Affected by Interest Rates

  • Government-Subsidized loan: If you are the recipient of a government-subsidized direct loan, the government will pay your interest while you are in school. This means that your loan balance will not increase. After graduation, the interest becomes your responsibility.
  • Parent PLUS Loan: There are no government-subsidized loans for parents, and regular repayments are scheduled to begin 60 days after the loan is disbursed.
  • Unsubsidized Loan: The majority of students will have unsubsidized loans where interest is charged from day one. If you have this type of loan, sometimes a lender will not require you to make payments while you are still in school. However, the interest will accrue, and when you graduate you’ll find yourself with a loan balance higher than the one you started with. This is known as capitalization. 

Here’s an example: In your freshman year, you borrow $7,000 at 3.85%. By the time you graduate in four years, this will have grown to $8,078 – an increase of $1,078. Here’s the math: 7,000 × 0.0385 × 4 = $1,078 (Click here for ELFI’s handy accrued interest calculator.)

 

How is Student Loan Interest Calculated?

When you begin to make loan payments, the amount you pay is made up of the amount you borrowed (the principal) and interest payments. When you make a payment, interest is paid first. The remainder of your payment is applied to your principal balance and reduces it. 

 

Let’s suppose you borrow $10,000 with a 7% annual interest rate and a 10-year term. Using ELFI’s helpful loan payment calculator, we can estimate your monthly payment at $116 and the interest you will pay over the life of the loan at $3,933. Here’s how to determine how much of your monthly payment of $116 is made up of interest.

 

1. Calculate your daily interest rate (also known as your interest rate factor). Divide your interest rate by 365 (the number of days in the year).

 

.07/365 = 0.00019, or 0.019%

 

 

2. Calculate the amount of interest your loan accrues each day. Multiply your outstanding loan balance by your daily interest rate.

 

$10,000 x 0.00019 = $1.90

 

3. Calculate your monthly interest payment. Multiply the dollar amount of your daily interest by the number of days since your last payment.

 

$1.90 x 30 = $57

 

How is Student Loan Interest Applied?

As you continue to make payments on your student loan, your principal and the amount of accrued interest will decrease. Lower interest charges means that a larger portion of your payments will be applied to your principal. Paying down the principal on a loan is known as amortization.

 

How Accrued Interest Impacts Your Student Loan Payments

The smart money approach is avoiding capitalized interest building up on your loan while you are in school. This is because choosing not to pay interest while in school means you will owe a lot more when you come out. The more you borrow, the longer you are in school, and the higher your interest rates are, the more profound the impact of capitalization will be.

 

How to Find the Best Student Loan

When looking for the best student loan, you naturally want the lowest interest rate available. With a lower interest rate, the same monthly payment pays down more of your loan principal and you will be out of debt more quickly. Talk to ELFI about our private student loan offerings by giving us a call today!

 

Learn More About ELFI Student Loans

 

Terms and conditions apply. Subject to credit approval.

 

NOTICE: Third Party Web Sites

Education Loan Finance by SouthEast Bank is not responsible for and has no control over the subject matter, content, information, or graphics of the websites that have links here. The portal and news features are being provided by an outside source – The bank is not responsible for the content. Please contact us with any concerns or comments.

Four Student Loan Repayment Strategies To Avoid

Updated November 13, 2019

According to an article published by The Wall Street Journal, 2016 graduates have set the newest record for graduating with the most student loan debt — an average of $37,172. With America’s accumulated student debt exceeding $1.2 trillion, and at least two-thirds of American graduates leaving their respective universities with some kind of debt. The article however, still remains positive, stating that new graduates should see a greater return on their educational investment, thanks to the potential to earn a higher income over their lifetime.

 

Even with this news, it is hardly a surprise that those owing tens of thousands of dollars (or more) in student loan debt are looking for various ways to pay it back faster and save a little money in the process. While a variety of helpful strategies do exist, it may be best to avoid certain repayment strategies, including the following:

 

1. Only Paying the Minimum Payment

Paying a loan’s minimum monthly payment is necessary to pay bills on time and to protect a borrower’s credit score. However, only paying the minimum payment and nothing more will be more costly in the long run because it allows more interest to accrue. Paying more than the minimum payment, even if just by a modest amount each month, is one of the easiest ways to reduce any form of debt — whether it is student loan or credit card related — and foster long-term savings.

 

Pay attention to the interest rates of all student loan debts and see which is more effective to pay off first. For the greatest money-saving potential, try to pay down student loans with higher interest rates first. A helpful way to do so is by paying more than the minimum payment or through strategies such as student loan refinancing.

 

2. Making Life-Long Payments

“Life-long” payments happen when a loan’s life (loan term) is extended to keep the monthly payment as low as possible. When borrowers first start chipping away at what is owed on a loan, the need to keep monthly payments as low as possible by extending the life of the loan is understandable. However, extending the loan’s term can be a costly option. For instance, doubling the repayment term from 10 to 20 years – and paying the minimum monthly payment (mistake #1 above) – could double the interest that a borrower will pay back over the life of a loan.

 

Instead of creating a “life-long” repayment plan, borrowers should instead consider refinancing their student loans in order to potentially qualify for a better interest rate. However, if extending the term creates a payment necessary to maintain a comfortable budget in the near term, borrowers can often offset some of the additional long-term cost by voluntarily making higher payments as their income increases.

 

3. Tapping Into Retirement Accounts to Pay Off Student Loans

Many people have a tendency to avoid thinking about their financial future, especially when other payments are due in their present. However, it is important to avoid withdrawing money invested in retirement plans to pay off student loans. Tapping into 401(k)s or other retirement plans to pay off student (or other) loans depletes money that may be needed later in life, and it also could result in reduced earnings potential of their savings or retirement accounts.

 

Instead of borrowing from or delaying contributions to retirement accounts to pay student loans, consider how refinancing student loans may create a more manageable, money-saving payment plan. Learn more about managing your 401k and paying off student debt.

 

4. Delaying or Missing Student Loan Payments

Delaying or missing payments on any type of debt — student loans, credit cards, or other financial commitments — is not a good financial decision and could impact your credit scores and future ability to borrow money. Good credit scores are important for receiving better rates on future loans, so doing everything you can to avoid credit score setbacks is essential. To remain in good standing with current or future creditors, borrowers should pay at least their minimum monthly payments.

 

You may also want to pay more than the monthly minimum payment to improve your debt to income ratio, another factor in your credit standing. Then when the time comes to refinance student loans or apply for a loan on a major purchase, borrowers may be more likely to receive a better offer with better terms and interest rates.

 

Benefit from On-Time Payments of Loans

Financial responsibility starts with paying your student loans on time each month. Making on-time payments are important to your overall credit score and can be beneficial when you refinance your student loans, as it may lead to better interest rates and terms. When student loans are refinanced with Education Loan Finance, borrowers are able to make payments greater than the minimum (without penalty), thereby increasing the likelihood of paying off their student loans more quickly and at a lower cost.* For the greatest money-saving potential, always be diligent and disciplined with the repayment of student loans.

 

What’s the Best Way to Repay Student Loans? 

 


 

*Subject to credit approval. Terms and conditions apply.

 

NOTICE: Third Party Web Sites

Education Loan Finance by SouthEast Bank is not responsible for and has no control over the subject matter, content, information, or graphics of the websites that have links here. The portal and news features are being provided by an outside source – The bank is not responsible for the content. Please contact us with any concerns or comments.