Are Student Loans Simple or Compound Interest?
Understanding how interest accrues on student loans is important. This article breaks down interest and student loans.
The difference between simple and compound interest doesn't sound like much in a vacuum. But when you look at that difference in the context of five or even six figures of student loan debt, it starts to feel like a more pressing issue.
Let's review the difference between simple and compound interest and then look at which types of loans charge which kind of interest.
Are Student Loans Simple or Compound Interest?
There are two ways that lenders can charge interest on your student loans: simple interest and compound interest. Simple interest means that the interest is being charged only on the remaining balance owed, while compound interest means that interest is being charged on the remaining balance and the subsequent interest accrued.
Simple interest is better than compound interest when you’re a borrower because less interest accrues during the life of the loan. Fortunately, the federal government charges simple interest on all of its student loans, and most private lenders also use the simple interest formula.
To find out how much interest you’re being charged, you’ll need to calculate the simple interest formula. Here’s how it works. First, take your annual interest rate and divide it by 365 to find your daily interest rate. Then, multiply the remaining principal by the daily interest rate.
For example, let’s say your interest rate is 6%, making your daily interest rate 0.00016438356. Your remaining loan balance is $50,000, so your daily interest amount is $8.22. For a 30-day statement period, your total interest would be $246.58.
During a normal repayment period, borrowers will accrue interest only via the simple interest formula. However, borrowers with federal unsubsidized student loans and private loans may have interest accrue and then compound. Borrowers with subsidized federal loans may or may not have interest accrue during deferment but may have interest accrue and compound during forbearance.
Here’s how compound interest can affect your student loan balance. Let’s say you defer your loans for a year and don’t make any payments during this time. Interest will still accrue during the year and will be added to your remaining principal balance. This is known as capitalization.
Capitalization will cause your future monthly payments to increase along with the total interest amount since the loan principal has increased. Borrowers who defer their student loans will often find that their loan balance has ballooned past what they originally borrowed — especially if they defer their loans for several years.
How to Pay Less Interest
Because the interest rate plays the biggest role in how much interest you pay over the life of the loan, you should find a lender with the lowest possible rate. That’s where Juno comes in.
Juno has some of the lowest interest rates available for both undergraduate and graduate student loans. For undergraduate student loans, the interest rates range from 2.99% APR to 11.78% for a fixed-rate loan and between 0.99% APR and 10.44% APR for a variable-rate loan.
For graduate student loans, the interest rate ranges from 2.99% APR to 6.14% APR for a fixed-rate loan and from 0.99% APR to 5.77% APR for a variable-rate loan.
Juno also offers an interest-rate guarantee. If you find a lower interest rate from another lender, you can bring it to Juno. If Juno verifies your claim, you’ll receive a better offer from Juno.
For the 2021-2022 school year, the interest rate for a federal undergraduate student loan is 3.73%. For graduate students, the interest rate is 5.28% for a Direct Unsubsidized Loan or 6.28% for a Direct PLUS Loan.
Here's how much you could save by choosing a Juno student loan. Let's say you borrow $50,000 for a graduate student loan with a 10-year term. If you choose a federal student loan with 5.28% interest, you’ll pay $537.20 a month and $14,464 in total interest.
If you borrow $50,000 from Juno with a 4% interest rate and a 10-year term, you’ll pay only $506.23 a month and $10,748 in total interest. That’s a savings of more than $3,000.
Borrowers applying for an undergraduate loan will need a co-signer to qualify with Juno. The co-signer will be legally responsible for your student loans if you default.
Graduate students may or may not need a co-signer, depending on their credit score and if they’re employed. Applying with a co-signer may yield lower interest rates and could save hundreds in total interest over the life of the loan.
Zina Kumok is a freelance writer specializing in personal finance. A former reporter, she has covered murder trials, the Final Four and everything in between. She has been featured in Lifehacker, DailyWorth and Time. Read about how she paid off $28,000 worth of student loans in three years at Conscious Coins.
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