You will receive a monthly bill for your student loan interest.
However, the way interest rates are calculated can vary. For instance, federal student loans accrue daily and follow a simple interest model.
On the other hand, some private lenders calculate loan rates based on compound interest.
Understanding whether your student loan interest is billed monthly or calculated yearly is not only crucial for making timely payments but also for devising a solid repayment plan.
You’ll learn more in this article.
Key Takeaways
- Student loan interest accrues daily but is billed monthly on your balance.
- Federal loans use simple interest; some private loans may use compound interest.
- Fixed rates are common in federal loans, while private loans offer variable or fixed rates.
- Repayment strategies, like refinancing or IDR plans, help manage and reduce debt effectively.
How Student Loans Really Work
First, let’s establish some foundational knowledge.
What is Interest?
Interest is the cost of borrowing money, expressed as a percentage of the loan amount.
When a lender provides a loan (principal), they charge an extra amount (interest). This amount increases the total amount you owe over time.
Interest rates may be fixed or variable, depending on the loan type.
Federal loans always have fixed interest rates, which stay the same throughout the loan’s life. On the other hand, private student loans can have a fixed or variable interest rate—most lenders offer both options.
The nature of the interest rate would determine how the lender calculates the outstanding balance.
For example, variable interest rates fluctuate, which means you could end up paying different interest rates each month.
When Does Interest Start Adding Up?
Interest can start accruing as soon as you receive your loan. This is especially true for private loans, but it’s a bit different for Federal loans.
A federal student loan can be subsidized or unsubsidized. For unsubsidized loans, your interest starts accruing the moment the loan is disbursed, while the interest for direct subsidized loans starts accruing after the post-graduation grace period.
Either way, debt can accumulate if you don’t know how to calculate your interest rates and understand their impact on your overall debt.
How Is Student Loan Interest Accrued: Monthly or Yearly?
💡 interest is calculated using an annual rate but accrues daily and is billed monthly
When you take out a student loan, you usually agree to a specific interest rate. This is referred to as an annual interest rate (APR). It represents the interest you’ll pay over a year, expressed as a percentage of your loan balance.
For instance, if your loan has a 5% APR, theoretically, you would owe interest amounting to 5% of the principal over one year.
Regardless of the APR, the actual interest charging process occurs daily on the current balance of your loan. The loan provider calculates this daily interest by dividing the annual rate by 365.
Mathematically:
(Interest Rate ÷ 365) x outstanding loan balance = Daily interest accrual
For example, with a $10,000 loan at 5% interest, the daily interest is roughly $1.37. This adds up to the total interest you’ll be charged.
How about monthly?
We’ve established that the agreed-upon interest rate is expressed as an annual percentage, but it is applied to the balance daily.
Each month, the total accrued interest (from daily accruals) is calculated and added to your loan balance. You’re required to make a payment “each month” that includes both interest and a portion of the principal balance.
If you only make the minimum payment, most of it will go towards interest, with only a small portion reducing the principal. To avoid debt piling up so quickly, you’ll need to prepare and follow a repayment plan.
The Impact of Having a Repayment Strategy
When student debts pile up, there are usually two underlying reasons: a poor repayment strategy or a lack of discipline in following one.
This is why we at Student Loan Professor are committed to helping students create and stick to a workable repayment strategy.
But what exactly is a repayment strategy?
A repayment strategy is a plan or approach designed to pay off debt in the most efficient and manageable way possible. It considers your financial situation, budget, and long-term goals.
Some tactics used here include:
- Standard Repayment Plan: This plan divides your loan balance into equal monthly payments over a fixed period (usually 10 years). This is the quickest way to pay off your debt without making additional payments.
- Income-Driven Repayment Plans: IDR plans adjust your payments based on your income and family size, and the term can extend to 20-25 years.
- Refinancing: This strategy involves securing a new loan with a lower interest rate to pay off the existing one. This is an optimal choice for individuals with strong credit scores or consistent incomes.
- Loan Consolidation: You can consolidate multiple student loans into one new loan with a single monthly payment and potentially lower the rate.
Plan Your Way Out of Debt
You’ve learned that student loan interest rates accrue daily but are billed monthly. We’ve also learned that these interest rates can be variable or fixed, and proper planning can ensure you’re not stuck with a huge debt pile in the long run.
We are also dedicated to ensuring that you not only learn these lessons but also put them into action. Sign up with us today to manage your student loan needs.
Brandon Barfield is the President and Co-Founder of Student Loan Professor, and is nationally known as student loan expert for graduate health professions. Since 2011, Brandon has given hundreds of loan repayment presentations for schools, hospitals, and medical conferences across the country. With his diverse background in financial aid, financial planning and student loan advisory, Brandon has a broad understanding of the intricacies surrounding student loans, loan repayment strategies, and how they should be considered when graduates make other financial decisions.
