What to Know About Federal Student Loan Interest (2024)

Interest: The Basics

Interest on a loan is essentially the cost charged by a lender for borrowing their money. Think of it as the price you pay for using someone else's funds to fulfill your immediate financial needs.

When you take out a loan, you agree to repay not only the amount you borrowed (the principal) but also the interest that accrues over the life of the loan. This interest is a key component of the total repayment amount.

Federal Student Loan Interest Rates

Federal student loan rates are set annually by Congress and reflect market conditions as well as specific educational contexts. These rates vary not only by the year in which the loan is disbursed but also by the type of loan and the borrower's degree level.

For example, the types of loans available to undergraduate students (direct subsidized loans + direct unsubsidized loans) often have a lower interest rate than those available to graduate/professional students or parent borrowers (Plus loans.). New rates apply to student loans disbursed from July 1 to June 30 of the following year.

Once your federal student loan is disbursed, the interest rate typically remains the same for the duration of the loan; this is referred to as a fixed interest rate. While most federal student loans disbursed after 2006 have a fixed rate, some older loans might have variable interest rates—so be sure to check!

Since these rates are typically fixed, the only way to change the interest rate of your federal student loans is by refinancing through a private lender. However, refinancing federal loans with a private lender means losing federal loan benefits like income-driven repayment options and federal loan forgiveness.

More information about current student loan interest rates can be found here.

How do I Find the Interest Rate(s) on My Federal Loan(s)?

To find the interest rate on your federal student loan, you can follow these steps:

1. Log in to Your Federal Student Aid Account: Go to studentaid.gov and log in using your FSA ID. If you don't have an FSA ID, you can create one on the same website.

2. Access the Dashboard: Once logged in, navigate to your dashboard, which provides an overview of your loan details.

3. Check Your Loan Details: In the loan summary section, you should be able to find information about each of your federal student loans, including the interest rates. Remember, federal student loans usually have fixed interest rates, which means they don't change over the life of the loan.

4. Review Your Loan Documents: The interest rate should also be stated in the original loan documents you received when you first took out the loan.

5. Contact Your Loan Servicer: If you're unable to find the interest rate online or don't have your original loan documents, contact your loan servicer directly. They can provide you with the current interest rate(s) on your loan(s.)

How Interest Accrues on Federal Student Loans

A common misconception is that federal student loans accrue compound interest; however, they accrue simple interest (thankfully!). Simple interest is calculated only on the principal balance, meaning the interest amount does not increase over time unless the principal balance increases.

Compound interest, on the other hand, means that interest is calculated on both the principal and the accumulated interest, which causes significantly more interest to accrue over time.

However, it's important to note that under certain circumstances, unpaid interest can be capitalized, meaning it is added to the principal balance, and future interest accrues on this higher amount. While this isn’t traditional compound interest, it can still significantly increase the total amount of interest that you’ll pay over time.

Another important thing to know about federal student loan interest is that it typically accrues DAILY. Yes, that's right—every single day.

You should be able to see your daily interest charges on your monthly statements but it's a good idea to make sure you're being charged properly (especially if you're reading this is 2024.)

Luckily, there's an easy formula you can use to figure out how much interest your loans should accrue daily.

How to Calculate Your Daily Interest Charges

The formula for calculating daily interest on student loans is:

Daily Interest = Principal * Annual Interest Rate / 365

Here's a breakdown of the formula:

To calculate the daily interest, multiply the principal balance by the annual interest rate. Then, divide this number by 365 to spread the annual rate across each day of the year.

Principal Balance: This is the current principal balance, NOT your outstanding balance. When you look at your statement, you should be able to see both your principal balance and your outstanding balance. Your outstanding balance includes interest and should not be used to figure out your daily interest.

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Interest Rate: This is the interest rate of your loan, expressed as a yearly rate. It's typically given as a percentage.

365: is equal to the number of days in the year. If you want to be super precise you can you 365.25 to account for leap years–but it shouldn’t make more than a few cents difference.

Example:

To illustrate, let's walk through an example.

Let’s say you have a federal student loan with a principal balance of $20,000. The annual interest rate on your loan is 4.5%.

Step 1: Identify the Principal Balance and Annual Interest Rate

Principal Balance = $20,000Annual Interest Rate = 4.5% (which is 0.045 in decimal form)

Step 2: Use the Daily Interest Formula

The formula for daily interest is:

Daily Interest = Principal * Annual Interest Rate / 365

Step 3: Plug in the Values and Calculate

So, you would calculate the daily interest as follows:

20,000 * 0.045 = 900900/365 = 2.4657

Daily Interest = $2.47 (rounded to the nearest cent)

If you’re looking at this math and thinking, 'Wow, no thanks,' or if you simply don’t want to go through the trouble of recalculating this number as you make payments, my Student Loan Interest Worksheet will do all the work for you.

Why Understanding Your Student Loan Interest Matters

Accurate Budgeting + Planning: Knowing your interest rate and understanding how interest accrues on your student loans can help you estimate the total cost of your loans over time. This information is vital for budgeting and financial planning, and will allow you to make informed decisions about spending and saving.

Picking the Best Repayment Strategy: Understanding your loan's interest mechanics can help guide your repayment strategy. For instance, if you have multiple loans, you might choose to prioritize paying off the ones with higher interest rates first (a strategy known as the debt avalanche method) to save money on interest in the long run.

Want to see which of your loans is costing you the most? Grab my Daily Interest Worksheet.

Income-Driven Repayment Plan Considerations: For borrowers on income-driven repayment plans, understanding how interest accrues and capitalizes is vital. These plans can result in a situation where your monthly payment is less than the interest that accrues each month (negative amortization--i.e. your loan balance grows every month despite making payments), which can affect the loan balance and the potential amount forgiven at the end of the repayment period.

If you're on the SAVE plan whatever interest is not covered by your monthly payment will be covered by the government--this means your loans won't grow like they will on other IDR plans. However, the SAVE plan won't be the best plan for every borrower so make sure you research your options and pick the plan that best aligns with your situation and goals.

Refinancing Decisions: If you're considering student loan refinancing, understanding how interest currently works on your loans is crucial. This knowledge will help you evaluate whether it's worth refinancing, or not.

Being Able to Spot Issues If They Arise: I recently saw a post on Reddit where a borrower was charged over $300 in interest on $8k loans in just 9 days. While scenarios like this are (hopefully) uncommon, knowing how much interest your loans are supposed to accrue can help you advocate for yourself should something like this ever happen to you.

How Interest Works on the SAVE Plan (Saving on a Valuable Education)

Many borrowers are confused about how interest works on the SAVE plan--I can't tell you how many DMs I get saying "I'm on the SAVE plan but I'm still accruing interest what do I do?" To be clear, while the SAVE plan does offer a very generous interest benefit, it’s important to note that interest still accrues on the SAVE plan.

Here’s how it works:

On the SAVE Plan, interest accrues daily. However, if you're on the SAVE Plan,100% of the interest not covered by your monthly payment will be eliminated.

For example, let's say you accrue $500 per month in interest, but based on your income, your monthly payment is only $200. Instead of the $300 in interest being added to your outstanding balance, the government will cover the $300 in interest not covered by your monthly payment.

Why Does This Matter?

Previously, if your monthly payments did not cover the amount of interest you accrued each month, your loan balance would continue to grow despite making payments. Under the SAVE Plan, borrowers will no longer see their balances grow due to unpaid interest.

If you're interested in learning more about the SAVE plan and the application process you can find more details here.

How to Save Money on Interest

Pay off Your Loans Quickly: While easier said than done, paying off your student loans quickly can result in less interest paid.

Even making small, but consistent, extra payments can have a huge impact on the cost of repayment. Plus, there are no prepayment penalties for federal student loans, so you don’t need to worry about incurring additional fees if you pay off your loans early.

Keep in mind that paying off your loans early may not be the best plan for everyone. You’ll want to carefully consider your options and what repayment strategy will work best for you and your goals.

For example, if you’re pursuing forgiveness, making extra payments may not be the best option — so be sure to do your research!

Refinance with a Private Lender: The only way to change your interest rate is to refinance. This involves taking out a new loan with a private lender to pay off your federal loans. If you have a strong credit history and stable income, you might qualify for a lower interest rate, which can result in significant savings over the life of your loan.

However, be cautious with this option as you'll lose federal benefits, including eligibility for forgiveness programs, flexible repayment options, and forbearance/deferment options.

Sign up for Auto-Pay: Federal loan servicers offer a 0.25% interest rate discount when you sign up for auto-pay. This discount is sometimes referred to as an auto-pay discount. Most private lenders also offer an auto-pay discount, but you’ll need to reach out to your private lender for details.

While 0.25% isn’t a huge amount, it will still save you some money on interest over the life of your loans. Plus, signing up for auto-pay means you’ll never have to worry about missing a student loan payment.

NOTE: As of January 2024, some borrowers have reported issues with auto-debit, including being overcharged and/or not receiving the discount. If you opt into auto-debit, ensure that your account is being credited and charged properly.

Need Help with Your Student Loans?

If you need assistance reviewing your loans or are seeking a customized student loan plan, I recommend Student Loan Planner. Everyone at Student Loan Planner holds a Chartered Financial Analyst (CFA), Certified Financial Planner™ (CFP®), or Certified Student Loan Professional (CSLP) designation.

They can help you create a personalized repayment plan based on your individual situation and goals. Student Loan Planner is the only service I recommend for personalized student loan assistance.

Struggling with Your Mental Health?

If you're feeling overwhelmed by student loan debt, remember that you are not alone, and help is available:

National Suicide Prevention Lifeline: If you are having suicidal thoughts, contact 1-800-273-8255 for support and assistance from a trained counselor.

Crisis Text Line: Offers free, 24/7 support to people in crisis. Text HOME to 741741 to connect with a trained counselor.

Debtors Anonymous (D.A): If you're seeking community support, you may benefit from joining a group like D.A.

As always, this information is for EDUCATIONAL purposes only and should not be taken as advice. Please always conduct your own research.

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