How Student Loan Interest Works

Understand the true cost of borrowing for education

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You might be considering taking out student loans to finance your college education, or perhaps you’re already looking over your award letter. Be sure to consider the interest rate you’ll pay on your loan when you're weighing different options. Part of your total cost will be the interest accrued over your repayment period, regardless of the loan type.  

The government has suspended interest on federal student loans through September 30, 2021, due to the economic fallout of COVID-19.

There are different loan interest structures that can depend on your loan provider, as well as whether you’re an undergraduate or graduate student. Your credit history can factor in as well. Some of your interest might be tax deductible, no matter how you pay it.

Fixed-Interest-Rate Student Loans 

A fixed interest rate means that your rate won’t change while you’re in school, or while you're repaying your loan. Interest rates for federal Direct Subsidized, Direct Unsubsidized, and Direct PLUS student loans are between 2.75% and 5.30% for the period of July 1, 2020 through July 1, 2021.

Your rate depends on whether you’re an undergraduate or a graduate student, and whether the loan is subsidized. Fixed rates differ for Direct PLUS loans and standard Direct student loans as well.

A private lender’s fixed rate might include factors such as your credit history, your course of study, and your college or university, which federal loans don’t take into consideration.

Fixed Interest Rate Pros
  • Budgeting is easier. The total repayment amount can be calculated from the start

  • Loan refinancing might be available if you need to change your rate.

  • These loans are offered by private and federal student loan lenders

  • Federal fixed-rate loans offer a .25% interest reduction during repayment if you sign up for autopay.

Fixed Interest Rate Cons
  • Your interest rates won’t decrease—which is a possibility with variable interest rates.

  • This is the only option available with federal student loans.

  • Private student loan lender interest rates can depend on your credit history.

Variable Interest Rate Student Loans

Variable interest rates are offered primarily by private lenders, and they can fluctuate over the life of your loan in step with an index rate. This works much like an adjustable-rate mortgage. Your payments will vary as a result if the prevailing interest rate goes up or down.

Federal student loans don’t have variable interest rates unless your loan originated before July 1, 2006.

Variable Interest Rate Pros
  • They're offered by private student loan lenders.

  • They potentially offer low interest rates, depending on the index rate at any given time.

  • Rates can be lower than those for federal loans.

Variable Interest Rate Cons
  • Interest rates can rise.

  • They're not offered by the federal lending apparatus.

  • Interest rate changes can make it challenging to plan for long-term payments.

Subsidized Student Loans

Subsidized loans are offered to undergraduate students who can demonstrate financial need. They allow you to put off making payments until you’ve finished school. Financial need is defined as the difference between a school’s cost of attendance and your expected family contribution (EFC), according to the U.S. Department of Education.

"Expected family contribution" will be phased out and replaced by a "Student Aid Index" beginning with the 2023-2024 award year as part of the FAFSA Simplification Act.

The U.S. Department of Education subsidizes (or pays) your interest while you’re attending school if you're attending at least half-time and during the grace period. This is the first six months after you leave school. This is the case whether you're graduating, quitting school, or enrolling for less than half-time.

Subsidized Loan Interest Pros
  • They're available to those demonstrating need.

  • The government pays accruing interest while you’re in school and for the first six months afterward.

  • You don’t have to pay interest if you go into deferment, or during certain periods within select repayment plans.

Subsidized Loan Interest Cons
  • They're not available to students who can't demonstrate a financial need.

  • They're not available to graduate students.

  • Undergraduates are capped at $23,000 as a lifetime total.

Unsubsidized Student Loans

Federal unsubsidized loans are offered to all students, independent of financial need, often to supplement subsidized loans. Your university considers your financial aid needs and the cost of attendance when awarding unsubsidized loans.

You’re responsible for paying interest on unsubsidized loans at all times. You can defer interest while you're in school or during the grace period, but it will still accrue and be added to your principal balance when you start making payments. 

Unsubsidized Loan Interest Pros
  • They're available to all students, not just those showing financial need.

  • You can defer interest while you're in school and during grace periods.

  • They're available to graduate students.

  • The interest rate is lower than the PLUS loan interest rate.

Unsubsidized Interest Cons
  • Unpaid interest begins accruing during school and grace periods.

  • Interest is added to your final bill upon graduation or at the end of any grace period.

  • There's a $138,500 cap in total subsidized and unsubsidized loans for graduate and professional students.

  • Graduate unsubsidized loans have a higher interest rate than undergraduate loans.

Student Loans With Grace Periods 

Most federal student loans offer a six-month grace period, except Direct PLUS loans. These are primarily for parents and graduate students. Most private student loans don’t offer grace periods, either, but check with your lender to be sure.

Your grace period might be extended if you’re called to active duty military service, or if you return to school before your grace period ends. Your grace period might end early if you consolidate your loans.

The Bottom Line

The total student loan-repayment amount depends on the type of loan you take out, the total loan amount, the loan interest rate, the duration of the repayment period, and your chosen repayment plan. There are still a few options that might help you save money on student loan interest, however:

  1. Accept subsidized loans before resorting to unsubsidized loans.
  2. Shop around for a private student loan interest rate that works for your budget. 
  3. Try paying some or all of your interest while you’re in school, if you're financially able. The sooner you can repay the loan, the less interest will accrue.
  4. Ask your student loan servicer whether you can receive an interest-rate reduction if you enroll in autopay and make all payments on time, and whether any other discounts are available. 
  5. Paying off your student loans on a faster timetable decreases the total amount of interest you'll end up paying after you graduate, although your payments will be higher. 

You might also consider refinancing your student loan to get a better interest rate, or consolidating your loans to bring down the average rate.