Janice Lozano
Student loan interest accrues daily, in most cases starting the day the loan is disbursed. This means that borrowers can expect to pay more than they originally borrowed. While it is possible to defer payments, interest continues to accrue, and interest will be capitalized – or added to the principal amount. This will increase the total loan cost. However, if you pay your accrued interest before it capitalizes, you can keep your total loan cost down.
| Characteristics | Values |
|---|---|
| Interest accrual start date | The day the loan is disbursed |
| Interest accrual frequency | Daily |
| Interest capitalization | Occurs at the end of the separation or grace period, or at the end of forbearance or deferment |
| Interest payment options | Auto-debit, online, mobile app, by phone, mail, or third-party bill-pay services |
| Interest payment regulations | Payments are first applied to fees, then accrued interest, and finally the principal |
| Interest calculation | Percentage of the current principal |
| Interest rate types | Fixed, variable |
| Interest rate calculation index | Secured Overnight Financing Rate (SOFR), London Interbank Offered Rate (LIBOR) |
| Interest rate calculation factors | Loan balance |
| Interest coverage | Up to $2,500 of student loan interest paid may be claimed on tax returns, depending on income and tax filing status |
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What You'll Learn
Interest accrual and capitalization
Interest accrual refers to the accumulation of interest charges on your student loan balance. Interest typically starts accruing from the day your loan is disbursed, and it can accrue daily. This means that even before you begin repaying your loan, the interest charges are accumulating. The interest accrual process can result in you paying more than the original loan amount.
Capitalization occurs when the accrued interest is added to your loan's principal balance. In other words, it is the act of converting the accrued interest into capital or principal. This typically happens during periods when you are not required to make payments, such as during deferment, forbearance, or grace periods. For example, if you choose to request a student loan deferment, you won't have to make principal and interest payments during that time. However, the interest will continue to accrue, and at the end of the deferment period, the accrued interest will be capitalized, increasing your loan balance.
Federal student loans may have specific circumstances under which interest is capitalized. For instance, for Direct Loans and other federally-owned loans, interest is capitalized after a deferment on an unsubsidized loan or if you are repaying your loans under an income-based repayment plan and no longer qualify for income-based payments.
To minimize the impact of interest accrual and capitalization, it is advisable to pay down your accrued interest before it capitalizes. This can help keep your total loan cost down. Additionally, if you've chosen the interest repayment option for your student loans, your interest shouldn't capitalize since you've been paying it as it accrues. Making small additional payments or paying off some or all of your accrued interest before the capitalization period can help you avoid or reduce the amount of capitalized interest.
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Payment strategies
Student loan interest accrues daily, in most cases starting the day the loan is disbursed. The interest is calculated as a percentage of the current principal, and there are two primary types: fixed and variable. A fixed interest rate stays the same for the life of the loan, while a variable interest rate may change.
Interest accrual can increase the total loan cost. Paying accrued interest before it capitalizes can help keep costs down. Capitalization occurs when unpaid interest is added to the loan's principal, and it can happen at certain points, such as the end of a grace period or forbearance. If you've chosen the interest repayment option, your interest shouldn't capitalize because you've paid it as it accrued. However, if you're making fixed payments or deferring them, try to make small additional payments or pay off some or all of your accrued interest before the capitalization period.
For Direct Loans and other federally-owned loans, interest capitalization happens after a deferment on an unsubsidized loan or if you're repaying under an income-based repayment (IBR) plan and no longer qualify for income-based payments or leave the plan. If you have certain older federal loans not owned by the government, interest may capitalize after the grace period or a deferment on an unsubsidized loan, after specific types of forbearance, or if you're repaying under an IBR plan and no longer qualify for income-based payments or exit the plan.
Federal student loans offer income-driven repayment plans, providing flexibility based on income. These plans may allow for lower monthly payments, and in some cases, a $0 payment. Additionally, depending on your income and tax filing status, you may be able to claim up to $2,500 of student loan interest paid in a year on your tax return.
To make payments, you can use auto-debit, online platforms, mobile apps, phone, mail, or third-party bill-pay services. Understanding how interest accrues and how payments are applied can help you strategize efficient repayment. Payments are typically applied to outstanding fees, accrued interest, and then the principal. Any extra payment beyond the monthly bill is often applied to the following month's bill.
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Income-driven repayment plans
Income-driven repayment (IDR) plans are monthly student loan payments that are set at an amount that is intended to be affordable based on your income and family size. With an IDR plan, your monthly payment will most likely be a percentage of your discretionary income. This percentage will vary from person to person. The Federal Student Aid Office of the U.S. Department of Education offers four types of IDR plans:
- REPAYE Plan: Generally 10% of your discretionary income. Any borrower with eligible federal student loans can make payments under this plan.
- PAYE Plan: Generally 10% of your discretionary income, but never more than the 10-year Standard Repayment Plan amount. To qualify, the payment you’d be required to make must be less than what you would pay under the Standard Repayment Plan with a 10-year repayment period. You must also be a new borrower.
- IBR Plan: Generally 10% of your discretionary income if you’re a new borrower on or after July 1, 2014, but never more than the 10-year Standard Repayment Plan amount. Generally 15% of your discretionary income if you’re not a new borrower on or after July 1, 2014, but never more than the 10-year Standard Repayment Plan amount. To qualify, the payment you’d be required to make must be less than what you would pay under the Standard Repayment Plan with a 10-year repayment period.
- ICR Plan: Any borrower with eligible federal student loans can make payments under this plan. This plan is the only available income-driven repayment option for PLUS loan borrowers with dependents.
Most federal student loans are eligible for at least one IDR plan. However, it's important to note that your loan type can affect your eligibility for each IDR plan. Defaulted loans are not eligible for any IDR plans. To remain in an IDR plan, you must apply and recertify your plan each year. You can use the Loan Simulator to estimate your monthly payments under different repayment plans.
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Loan agreement terms
When applying for a private student loan, borrowers will need to sign a loan agreement. A loan agreement is a legally binding contract between the borrower(s) and the lender that outlines the terms of the loan, including the amount to be repaid, the interest rate, and any other conditions. All parties listed on the loan must sign the loan agreement. Loan agreements must be signed for each loan borrowed.
The lender must provide a final disclosure once the loan is finalized. This statement includes pertinent loan details, such as the amount borrowed, the interest rate, any fees, and the total cost of the loan. The repayment term specifies the length of time the borrower has to repay the loan, typically expressed in years. The repayment term has a direct impact on the total cost of the loan.
Interest rates can be either fixed or variable. A fixed interest rate remains the same for the life of the loan, while a variable interest rate may fluctuate. Variable rates can increase the total loan cost over time. Federal student loans are required by law to provide a range of flexible repayment options, including income-based repayment plans, loan forgiveness, and deferment benefits.
Borrowers can lower their total loan cost by paying accrued interest before it capitalizes. Capitalization occurs when unpaid interest is added to the loan's current principal, increasing the amount on which interest is calculated. This typically happens at the end of a separation or grace period, or after a period of forbearance or deferment.
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Interest rates
There are two primary types of interest rates: fixed and variable. A fixed interest rate remains constant throughout the loan period, while a variable interest rate may fluctuate based on changes to the loan's index. For example, variable-rate Sallie Mae loans applied for after April 1, 2021, use the Secured Overnight Financing Rate (SOFR) as the index, whereas those applied for before this date used the London Interbank Offered Rate (LIBOR). Federal student loan interest rates are set by Congress, whereas private student loan interest rates vary by lender.
Interest accrual on student loans can occur daily or monthly, depending on the terms of the loan. During periods of deferment or forbearance, interest typically continues to accrue. For subsidized federal loans, the government pays the interest during certain deferment periods, such as while the borrower is still enrolled in school or during a post-school grace period. However, borrowers are responsible for interest accrual during forbearance, regardless of loan type.
To minimize the total cost of the loan, it is advisable to pay accrued interest before it capitalizes. Capitalization occurs when unpaid interest is added to the loan's principal balance, resulting in interest accruing on a higher amount. By making small additional payments or paying accrued interest before the end of the grace period, borrowers can reduce the amount of capitalized interest.
Borrowers should carefully review the promissory note and loan agreement to understand the interest rate, accrual, and capitalization terms of their student loans. This knowledge will enable them to strategize a repayment plan that can save them money over the life of the loan.
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Frequently asked questions
Yes, you can pay down accrued interest on your student loans. This can help keep your total loan cost down.
You can pay accrued interest through auto-debit, online, the Sallie Mae app, by phone, mail, or third-party bill-pay services.
If you don't pay accrued interest, it will capitalize, meaning it will be added to your loan's principal balance, and interest will accrue based on this new, higher amount.
You can use a calculator on the Sallie Mae website to figure out how your interest will accrue and the difference it will make if you pay your interest down.
