When you take out a student loan, you agree to repay more than the amount you borrow. In exchange for lending the money, the lender will charge an interest fee, which can significantly affect the cost of your loan and the time it takes to pay it back.
All lenders use different criteria to determine your student loan interest rate, so it’s important to compare different loan offers. Before taking out a student loan, make sure you understand how interest rates work and how they affect your student loan repayment.
How do student loan interest rates work?
Interest is the extra cost lenders charge you for borrowing money, expressed as a percentage of your loan principal amount. Your interest rate has a huge effect on your student loans. The higher the rate, the more interest you will pay each month. A borrower with a higher interest rate will have higher monthly payments than a borrower with a lower rate, even though they both withdrew the same amount originally. A higher rate also increases the overall cost of your loan.
Generally, choosing a longer repayment term will give you a higher interest rate and vice versa. However, your interest rate also largely depends on your credit score, income and more.
In general, interest on a student loan is compounded monthly, which means the amount you pay in any given month is based on the amount remaining on the loan.
Fixed vs Variable Interest Rates
Interest rates on student loans come in one of two forms: fixed or variable. With many lenders, borrowers can choose between fixed and variable rates when selecting a loan. They can also refinance later at a fixed or variable interest rate.
Fixed interest rates
As the term suggests, the fixed interest rates stay the same for the duration of your loan, which means your monthly payment will also stay the same. Fixed interest rates provide more certainty, which is worth it if you’re not a risk taker.
Floating interest rate
With variable interest rates, your interest rate may change over time as current student loan interest rates in the market go up and down. In general, variable interest rates are initially lower than fixed interest rates, which makes them more attractive. But they could get more expensive in the long run, especially if you have a long repayment term.
That said, if you have a short repayment period and market rates don’t rise too much during the term, a variable interest rate could possibly save you money.
Interest Rates on Federal and Private Student Loans
Student loans can come either from the US Department of Education or from private lenders. Federal and private student loans determine interest rates differently.
Interest Rates on Federal Student Loans
Federal student loan interest rates are set by Congress. Rates are standardized, meaning everyone who qualifies for a loan in a given year pays the same interest rate. However, federal student loan interest rates generally change from year to year.
Here’s how rates have changed over the past five years:
|Interest rates for 2017-18||4.45%||6.00%||7.00%|
|Interest rates for 2018-19||5.05%||6.60%||7.60%|
|Interest rates for 2019-20||4.53%||6.08%||7.08%|
|Interest rates for 2020-21||2.75%||4.30%||5.30%|
|Interest rates for 2021-22||3.73%||5.28%||6.28%|
Note: The new rates come into effect on July 1 of each year.
Private Student Loan Interest Rates
Unlike the federal government, private lenders use risk-based pricing to determine student loan interest rates. You must be manually approved by the lender and your interest rate will be determined by factors such as your credit score, income, other debt repayments and more. If you’re having trouble qualifying yourself for the lowest rates, you can always recruit a qualified co-signer.
As of April 13, 2022, major lender rates ranged from 0.94% to 12.99%.
|Serious||From 2.99%||From 0.94%|
|College Avenue||3.24% to 12.99%||0.94% to 11.98%|
|Citizens Bank||3.48% to 11.34%||N / A|
|Sally Mae||3.5% to 12.6%||1.13% to 11.64%|
|SoFi||3.47% to 11.16%||1.36% to 11.79%|
Most experts recommend maximizing your federal loans before taking out a private student loan. Private loans carry more risk than federal loans because they don’t offer protections such as access to income-tested repayment plans, forbearance and deferment options, or cancellation programs. student loan.
What factors affect your student loan interest rate?
The factors that determine your student loan rates depend on the type of student loan you take out. With federal loans, the two main factors are the type of loan you apply for and when the loan is disbursed.
With private student loans, several factors go into this decision, including:
- The lender: Each lender has their own criteria for calculating risk and determining how much to charge.
- Evolution of market interest rates: Lenders can use the London Interbank Offered Rate (Libor) or prime rate to determine their interest rates.
- Your credit score and credit history: Your credit score provides insight into your overall credit health, but lenders will also review your credit reports to determine how you’ve managed your debts in the past. A solid history can help you get a lower interest rate.
- Your co-signer: Applying with a co-signer can help you get a lower rate, especially if the co-signer has good credit.
- Your annual income: It’s important for lenders to understand if you can really afford to make your monthly payments. They will use your gross monthly income to get an idea of your ability to pay.
- Your other debt repayments: Lenders will use your gross monthly income and your other monthly payments to calculate your debt-to-income ratio. The higher the ratio, the more likely you are to be overwhelmed and miss a payment.
- The term of the loan: A long repayment term can pose a higher risk to lenders because it gives you more time to potentially miss a payment. It also increases the chances of the lender missing out on higher interest rates for new loans. Therefore, choosing a shorter repayment term could help you get a lower interest rate.
It is also important to keep in mind that the repayment term of your loan has a significant impact on the total amount of interest you will pay. For example, if you choose a 20-year repayment plan rather than a 10-year plan, you’ll end up paying more money overall because of the extended term.
What is a good interest rate for a student loan?
What counts as a good rate largely depends on the interest rate market at the time of the application. In some markets, 7% may be a bargain, while in others, 2% may be a plausible rate.
To get a measure of how good an interest rate is, one thing you can do is compare it to the federal student loan rate. Federal loans generally have reasonable interest rates. To get a similar or better rate on a private loan, especially a fixed rate loan, you need to have very strong credit.
A “good” interest rate can also be different for each borrower. A borrower with an average credit score or a short credit history should not expect to receive the lowest advertised rates; in this case, finding the best interest rate for your financial situation requires comparing personalized offers from several different lenders.
How to Calculate Student Loan Interest
Calculating interest on your student loans can help you determine the cost of your loans and show how much you could save by paying more each month. If you want to save time, use an online calculator to do the math.
If you want to do it yourself, the process only requires three steps:
- Find your daily interest rate: Take your interest rate and divide it by 365. If your rate is 2.75%, your daily rate would be 0.007534%.
- Calculate your daily accrued interest: Multiply your daily interest rate by your current loan balance to get your daily adjustment fee. With a balance of $15,000, your daily interest would be $1.13.
- Determine your monthly interest charges: Multiply your daily accrued interest by the number of days in your billing cycle. With a 30 day cycle, the monthly fee would be $33.90.
Remember that as your principal balance decreases, the amount you pay in interest also decreases. Also be aware that if you have a variable rate loan, your interest rate will fluctuate. Finally, if your lender charges compound interest, you will pay interest on both the principal loan amount and any unpaid accrued interest, which will increase your monthly payment.