Douglas Olsen
Student loan interest can be a heavy burden, but there are ways to reduce or avoid paying interest. Firstly, it's important to understand how interest accrues and affects repayment. Interest on student loans typically starts accruing daily from the day the loan is disbursed. While there are occasional pauses, such as during the pandemic, interest generally accumulates over time. To minimize interest payments, borrowers should aim to make timely payments and consider paying a little extra with each instalment. Additionally, borrowers can explore income-driven repayment plans, such as the SAVE plan, which prevent interest from accumulating as long as payments are made. It's also beneficial to avoid using credit cards or home equity to pay off student loans, as these can lead to higher interest rates and potential financial risks. Understanding these strategies can help borrowers make informed financial decisions and effectively manage their student loan interest.
| Characteristics | Values |
|---|---|
| Subsidized federal loan | The government will pay your interest while your loans are in a deferred status, for example, while you are enrolled in school or in your six-month, post-school grace period. |
| Unsubsidized loan | Interest accrues daily, starting the day your loans are disbursed. |
| In-school deferment | Even during in-school deferment, your unsubsidized loans will accrue interest. |
| Credit cards | Credit cards will cost you more in interest. |
| Home equity | If you refinance your loans using home equity and run into trouble paying your mortgage, you could lose your house. |
| Federal student loan forgiveness programs | Check offers against the only federal student loan forgiveness programs. |
| Delinquent loan | Private student loans may be reported delinquent as early as 30 days without a payment. Federal loans owned commercially in the Federal Family Education Loan (FFEL) program are considered delinquent at day 60. Federal loans (Direct and FFEL) owned by ED are reported delinquent at day 90 of no payment. |
| SAVE income-driven repayment plan | Borrowers can sign up for the SAVE plan, a new kind of income-driven repayment plan that prevents interest from accumulating as long as borrowers make their payments. |
| IDR plans | IDR plans set payment amounts based on the income of the borrower and forgive any remaining balance after they’ve paid for 20 to 25 years. |
| Auto-debit | Auto-debit automatically transfers the loan payments from the borrower’s bank account to the lender, reducing the likelihood of a late payment. Some lenders will reduce the loan’s interest rate by 0.25% or 0.50% as an incentive. |
| Federal income tax return | Borrowers can deduct up to $2,500 in interest on federal and private student loans on their federal income tax return. |
| Repayment term | Longer repayment terms lead to lower monthly payments but more interest over the life of the loan. |
| Early repayment | Many students start paying their student loans while they’re still in college, even when it isn't required. Starting repayment early can help you graduate with less debt. |
| Payment amount | If you send more than the amount due each month, the extra funds are first applied to any outstanding interest, and the remaining amount goes directly toward paying down your principal. |
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What You'll Learn
Understand how interest accrues and affects repayment
Understanding how interest accrues on student loans and its impact on repayment is essential for making informed financial decisions. Here are some key points to consider:
Interest Accrual
Interest on student loans typically begins to accrue daily from the day the loan is disbursed. This means that even during any grace period or deferment, interest is accumulating. It is important to note that interest accrual may differ depending on the type of loan, such as subsidized federal loans, where the government may pay the interest under certain conditions, including economic hardship or enrolment status.
Interest Rates
Interest rates on student loans can be of two types: fixed or variable. Fixed interest rates remain constant throughout the loan period, while variable interest rates fluctuate with the financial markets and may end up costing more over time. Understanding the interest rate associated with your loan helps in managing repayment expectations.
Loan Repayment
When making loan payments, the funds are typically applied first to any fees, then to interest, and finally to the principal amount. Initially, a significant portion of each payment may go towards interest charges, resulting in a slow decrease in the principal balance. However, as the principal amount reduces, so does the interest charged, making it crucial to pay down the principal as quickly as possible.
Strategies to Minimize Interest
There are several strategies to minimize the overall interest paid on student loans:
- Make timely payments: Late payments can damage your credit score and lead to higher interest rates on future loans.
- Pay extra: Paying even a small amount extra with each payment can help reduce the principal faster and decrease total interest charges.
- Avoid extending repayment terms: Longer repayment terms result in lower monthly payments but accumulate more interest over the life of the loan.
- Enroll in interest-saving plans: Explore options like the SAVE income-driven repayment plan, which prevents interest from accumulating as long as borrowers make their payments.
- Deduct interest on tax returns: Borrowers may be able to deduct student loan interest from their federal income tax returns, potentially saving hundreds of dollars.
By understanding how interest accrues and its impact on repayment, borrowers can make strategic decisions to minimize the overall cost of their student loans.
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Make payments on time
Making payments on time is one of the most important things to do when it comes to avoiding interest on student loans. Even a single late payment can have a detrimental effect on your credit score, which is intended to measure whether a borrower will repay their student loan debts on time. A lower credit score will likely result in being charged higher interest rates on future loans. Late payments can also mean that the borrower will not qualify for cosigner release.
To avoid late payments, you can set up auto-debit, which automatically transfers the loan payment from the borrower’s bank account to the lender. This not only reduces the likelihood of a late payment but may also result in the lender reducing the loan’s interest rate by 0.25% or 0.50%. However, some borrowers may not like the idea of the lender having direct access to their bank account. It is important to note that the borrower always remains in control and can stop the automatic payments at any time.
Making payments on time also means being aware of when payments are due. For example, payments are due even if the lender does not send the borrower a statement or coupon book. It is also important to be aware of the different types of interest rates. Fixed interest rates stay the same over the life of the loan, whereas variable interest rates change with the financial markets and may end up costing a lot more over the life of the loan.
Additionally, it is worth noting that federal student loans owned by the Department of Education (ED) do not charge late fees, but private student loans may be reported delinquent as early as 30 days without a payment. Federal loans owned commercially in the Federal Family Education Loan (FFEL) program are considered delinquent at day 60, and federal loans (Direct and FFEL) owned by ED are reported delinquent at day 90 of no payment.
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Pay a little extra with each payment
One of the best ways to avoid paying interest on student loans is to pay a little extra with each payment. This strategy can get you out of debt faster and save you money on interest. Here are some tips to help you make the most of this approach:
- Set up direct debit (autopay) to receive a 0.25% discount on your interest rate. With direct debit, your payment is automatically deducted from your bank account each month, ensuring timely payments. Contact your loan servicer to see if your loan is eligible for this interest rate reduction.
- When making extra payments, request that your servicer apply the additional amount to your higher-interest loans first. This will help you save the most on interest charges over time.
- Continue making monthly payments even if you've satisfied future payments. This will help you pay off your loan faster and reduce the total cost of your loan.
- Dedicate your tax refund to paying off your student loan debt. You may have received a tax refund because of the tax deduction for paying student loan interest. Using this refund to make an extra payment can further reduce your loan balance.
- Make a budget and explore debt reduction strategies to understand how your student loans fit into your overall financial picture. This will help you determine how much extra you can afford to pay towards your student loans each month.
By following these steps and paying a little extra with each payment, you can effectively reduce the interest charged on your student loans and accelerate your path to becoming debt-free.
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Enrol in the SAVE repayment plan
One way to avoid paying interest on student loans is to enrol in the SAVE repayment plan. Here are some key things to know about this option:
First and foremost, the SAVE repayment plan is a specific type of student loan repayment plan that offers certain benefits to borrowers. It is likely that payments for this plan will resume in late 2025, but it is more probable that they will restart in mid-2026. This timeline is subject to change, as the Department of Education could expedite the process, with the earliest possible date being December 2025.
Secondly, understanding the nuances of student loans can help you make more informed financial decisions. Interest accrues daily, typically starting the day your loans are disbursed. If you have a subsidized federal loan, the government will pay your interest under certain conditions, such as during your enrolment in school or a post-school grace period. The government will also cover interest during deferment periods resulting from specific circumstances like economic hardship, unemployment, or military deployment.
Additionally, it is important to be cautious when considering various repayment strategies. Avoid using credit cards or home equity to pay off student loans, as these options can lead to higher interest rates or the loss of borrower protections. Similarly, returning to school solely to delay loan payments may result in accruing more debt, potentially worsening your financial situation.
By staying informed about the SAVE repayment plan and its associated timelines, as well as understanding the unique traits of student loans and exercising caution with repayment strategies, you can make more effective decisions regarding your financial situation and potentially minimise the interest paid on your student loans.
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Deduct interest on federal and private loans from your tax return
If you've paid $600 or more in interest to a federal loan servicer during the tax year, you'll receive a Form 1098-E, Student Loan Interest Statement, from the entity to which you paid the student loan interest. This form is used by your federal loan servicer to report student loan interest payments to both the Internal Revenue Service (IRS) and to you.
You can deduct student loan interest on your federal tax return, which may benefit you by reducing the amount of tax you have to pay. Federal student loan borrowers could qualify to deduct up to $2,500 of student loan interest per tax return per tax year. If you are a higher-income taxpayer, the student loan interest tax deduction is reduced or eliminated. For example, if you are filing as Single, Head of Household, or Qualified Surviving Spouse, you can deduct up to $2,500 of paid student loan interest if your modified adjusted gross income (AGI) is $80,000 or less.
If you paid less than $600 in interest during the tax year and did not receive a 1098-E, you may contact your servicer for the exact amount of interest you paid during the year so you can then report that amount on your taxes.
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Frequently asked questions
There are a few ways to avoid paying interest on student loans. Firstly, if you have a subsidised federal loan, the government will pay your interest while you are still enrolled at least half-time in school, during your post-school grace period, or if you return to school at least half-time. Secondly, you can enrol in the SAVE repayment plan, which prevents interest from accumulating as long as you make your payments. Thirdly, you can make extra payments each month to cover the interest and reduce your principal balance faster.
The SAVE repayment plan is a new income-driven repayment plan offered by the Department of Education. Under this plan, interest will not accumulate as long as borrowers make their payments. This is because any interest above the monthly payment amount won't be charged and won't be capitalised, or added to the balance of the loan.
You can enrol in the SAVE repayment plan on the Department of Education website. If you have a REPAYE plan, you will be automatically shifted to the SAVE plan.
