Written by Kevin Payne
If you took out student loans to pay for college, you will likely have to pay them back at some point… eventually. What you may not know is how much your student loans could end up costing when it's all said and done. If you took out $12,000 in federal student loans, for example, it's more than likely you will pay more than that overall once you've sent the final payment.
The sticker price of student loans usually is different from what you end up paying, and it's because most student loans come with interest. Depending on the types of loans you received, and whether they accrued interest while attending school, you could end up paying significantly more money than you borrowed. Keep reading to learn more about student loan interest, how it works, and why it makes sense to pay into your loan's principal amount.
Interest is a cost charged by banks and other lenders for the privilege of borrowing money. When you take out student loans or other lending products, like a home mortgage, a personal loan, or get a credit card, the lender charges a fee on the amount borrowed. Interest is usually expressed as an annual percentage called an interest rate.
Interest rates vary depending on the type of student loan. Federal loans carry fixed interest rates based on the type of loan and when it was first disbursed. The following interest rates are for Direct Loans first disbursed on or after July 1, 2022, and before July 1, 2023:
Lenders typically base private student loan interest rates on a borrower's creditworthiness and other factors like income and other existing debt.
When you take out student loans, lenders generally charge interest on the full balance until you've paid it off completely. Lenders may charge simple or compound interest, depending on the type of lending. Student loans typically use simple interest, which is calculated using only the interest rate and principal balance. Compound interest calculates the interest on the principal balance and the interest that's accrued since your last loan payment.
You may have seen the term APR when taking out a loan or borrowing money. APR stands for annual percentage rate. It represents the yearly interest charged on loans, including fees. The higher the APR, the more interest you will pay on the borrowed amount.
With student loans, lenders typically roll interest into your monthly loan payment. Part of your monthly payment goes towards paying off the interest that accrued since your last payment, and the remaining portion goes toward paying down the loan principal.
The good news for federal borrowers is that the U.S. government paused student loan payments and extended a 0% interest rate due to the pandemic and the resulting economic environment. The payment and interest rate pause was recently extended to last at least until June 30, 2023.
Carrying student debt long-term can become a significant source of stress and anxiety. It can also delay or prevent you from pursuing other life and financial goals. In some cases, it might be wise to avoid paying off your student loans quickly, such as if you are pursuing student loan forgiveness or have an extremely low interest rate.
If you desire to pay off your debt and be done with it, paying into your loan principal is key.
One of the best ways to pay off your loans quicker is to make extra principal-only payments on your loan.
As mentioned, part of your loan payments goes towards accrued interest, with the rest going toward your loan principal. Early on in repayment, more of your payment goes toward interest than the principal amount. Over time, more of your payment goes toward paying down the principal. Making extra payments periodically reduces the total amount you pay interest on, speeding up the repayment process. More of your payments will go toward paying down the loan balance than toward accrued interest.
If you decide to pay extra toward your student loan balance, make sure your lender applies extra payments to the principal and not interest. Some lenders may automatically apply loan payments this way, but you may need to notify them or mark the payment somehow, depending on the lender's payment policies.
Besides the obvious benefit of having less debt, there are other reasons to pay off your student loans early, including:
Whether you make extra payments each month or apply windfalls (like tax return checks and work bonuses) to your loan, lowering the principal will help you pay off your student loans earlier than scheduled and save money in interest charges.
You can also refinance your student loan to a lower interest rate to save money. Keep in mind that if you refinance federal student loans, you'll lose access to federal protections like repayment plays, loan deferment and forbearance, and student loan forgiveness programs.