Interest is the cost of borrowing. When you borrow a federal student loan you are using federal funds for a period of time, and that use has a cost associated with it.
To better understand the effects of interest, you should know your principal balance. The principal balance is the original amount you borrowed, plus capitalized interest, less any principal payments.
There are different types of interest that can affect your student loan:
- Subsidized Federal Stafford Loans first disbursed to undergraduate students between July 1, 2010 and June 30, 2011 have a fixed interest rate of 4.5%.
- Unsubsidized Federal Stafford Loans borrowed on or after July 1, 2006 as well as subsidized Stafford Loans borrowed by graduate students have a fixed interest rate of 6.8%.
- The fixed rate for Federal PLUS Loans (for parents and for graduate students) is 7.9%.
Variable interest rates are tied to a certain index (depending on the type of loan and when it was received) and change periodically as the index changes. Student loans borrowed prior to July 1, 2006 had variable interest rates.
If you borrowed a loan prior to July 1, 2006, your initial interest rate was provided to you. Your interest rate should generally change each year, and your loan holder should inform you of any interest rate changes during the repayment period for your loan.
Daily interest = (Annual Interest Rate/365.25 days) X Unpaid Principal Balance
Example: Interest accrual based on a $2,625 loan with an annual interest rate of 9 percent Daily interest = (.068 / 365.25 days) X $3,500 = $.65160848733 per day
Capitalized interest is unpaid, accrued interest that is added to the principal balance of your loan. It is also called "compound interest." When interest is capitalized, your total debt increases. It is very important to make interest payments on unsubsidized Federal Stafford Loans, even when you are not required to (e.g., when you are enrolled in school at least half time or during your grace period or authorized periods of deferment). By making interest payments, you can save yourself a considerable amount of money over a standard 10-year repayment period.