Understanding student loan interest rates is the key to making smart borrowing decisions. Here’s a simple example that will demonstrate how your loan interest rate can add dollars to your debt. Let’s say you graduate with an average of $40,000 in student loan debt. A 4.5% rate of interest, which is the rate for federal loans, will add over $10,000 to your total loan amount over the life of the loan. That’s not an amount you can afford to overlook. When taking any loan and calculating your monthly payments, you must factor the total interest you need to pay into the calculation.
We’ve put together some of the basic facts you must know about student loan interest rates and how they affect your overall debt.
Know The Different Interest Rates
The most important thing to know about interest rates is that the rates on federal student loans are lower than the rates on private student loans. Rates also differ within the different types of federal loans.
This snapshot will give you a quick overview of the latest rates on different types of federal and private student loans.
- Federal Direct Subsidized Loans for undergrad students – 4.45%
- Federal Direct Unsubsidized Loans for undergrad students – 4.45%
The difference between the two is that the government pays the interest on Direct Subsidized Loans while you are in college and for the first 6 months after you graduate. With Direct Unsubsidized Loan, the interest starts accruing as soon as the loan is taken out. For the same amount that you borrow, you will end up paying much more with an unsubsidized loan.
- Federal Perkins Loans – 5%
- Federal Direct Unsubsidized Loans for grad or professional students – 6%
- Direct PLUS Loans, which are available only to parents, grad students and or professional students – 7%
- Private Loans – The interest rates on private student loans vary widely from one lender to another.
Fixed vs Variable Interest Rates
In addition the variations in the interest rates themselves, some loans have a fixed rate of interest while others have a variable interest rate. This can also affect the total amount of the loan.
With a fixed rate of interest, you know what the interest rate is at the time that you take the loan and you continue paying the same rate till you have paid off the loan completely. The advantage of taking a loan with a fixed rate of interest is that you know exactly how much the loan is going to cost you and how much you have to pay back every month. Market fluctuations do not affect your loan or the interest rate.
When you take a loan with a variable rate of interest, the interest rate may fluctuate frequently depending on how the stock market is doing. If you are lucky, the rates could drop down considerably, but on the other hand, they may also increase overnight. The advantage of taking a loan with a variable interest rate is that you get the benefit of a possible lower rate but the risk is that you could end up paying a higher rate too.
So does it make sense at all to take a variable interest loan? It may be worth it if you need the money for a short time and are planning on paying off the loan quickly. It also makes sense if you have a handle on market conditions and you know that interest rates are predicted to go down. If they do, you will benefit by having to pay a much lower overall rate. You must understand how the market works and you must also be willing to take the risk if you decide to take a variable rate loan.
What You Can Do To Prevent Your Interest From Spiraling Out Of Control
Of course, the best thing you can do is to take steps to borrow as little as possible. Add up all your potential expenses, from the cost of tuition, boarding and accommodation to the cost of books, stationary, traveling and all other incidentals. Calculate how much money you can earn from scholarships, grants, work study, raise by yourself, using family funds, gifts or loans from relatives or friends. The rest you will have to borrow.
Handling Student Loans
Unfortunately sometimes, even after taking all possible measures to minimize the amount you borrow, you just have to borrow more than you’d like to. Rather than forego a college education completely, you should learn how to handle your loan correctly.
One thing you can do is to pay back parts of the loan as and when you can. When you get some extra money, either as a gift or as payment for your work-study job, put it towards paying back your loan even while you are still in school. When doing this, you must specify to the lender that the money should go towards the principle and not the interest.
By default, lenders put early payments towards the next interest that is due. However, your principle amount stays the same and continues to accrue interest on the whole amount. When you put the early payment towards the principle, it helps reduce the amount of interest that accrues, saving you a substantial amount over the life of the loan.
For example, let’s say you borrow $20,000. If you make an early payment of $400 towards the next interest, the interest will keep accruing on the entire $20,000 but if you put the $400 towards the principle, the interest will only keep accruing on $16,000, which can make a huge difference to the amount you eventually have to pay back.
A final thought about student loan interest rates—Never presume anything. Very often, important terms and conditions are buried in the fine print. Read through everything carefully and if you have any doubts at all, ask the lender for clarifications, preferably in writing. Once you agree to the terms and conditions, you are legally bound by them.
Use College Raptor’s free Student Loan Finder to compare lenders and interest rates side by side!