Many students and families consider student loan debt to finance higher education. As a senior at the University of Delaware, I’ve seen billboards, banner ads, radio ads, television ads and even received a few direct mailers for different lenders.
Student loans are everywhere. But these ads don’t always paint the full picture for students and families. Student loans have a secret, and that secret is interest.
I talk with students every day who are unaware their student loan debt is currently accruing interest. The truth is, many private and federal student loans accumulate and capitalize interest while students are in school or during periods of deferment.
Unfortunately, not every student reads his or her promissory note in the age of online loan applications. I’d like to share a few tips to help you avoid compounding student loan interest, and hopefully put you on a path to beat your student loan debt.
What’s Compound Interest? What’s Capitalization?
I hate to start an article off with boring financial definitions. That being said, bear with me.
As a finance major, I’m pretty familiar with the concept of compound interest. At its simplest, when you borrow money you are charged interest.
Interest is a fee charged for lending you money. When you borrow money, you pay interest for access to the loan. Interest can be charged daily, weekly, monthly and even yearly.
When it comes to student loans, my interest is charged daily. If you fail to pay your interest as it accumulates, the interest you owe will be added to the principal of your loan. This is known as capitalized interest.
Simply stated, interest will be charged on both the loan principal and accumulated interest. The end result: Capitalized interest equates to a much higher total loan and education cost.
Federal and Private Student Loans
If you have student loans, odds are you have them through the federal government.
However, the rising costs of higher education have forced more and more students to use private student loans to fund their degrees.
The commercials I referenced earlier are from private student loan lenders. In contrast, federal student loans such as Stafford, Perkins and PLUS loans are offered by the Department of Education, which does not advertise directly.
Both federal and private student loans may accrue interest while you are in school.
- Unsubsidized loans do accrue interest
- Subsidized loans do not accrue interest (the DOE pays the accrued interest)
Federal unsubsidized loans are offered to every student who enters college and accrue interest while you are in school. Private student loans always accrue interest while you are in school. Before signing the promissory note, determine your types of loans and interest.
Private student loans typically have higher interest rates than federal student loans. Meaning, private student loans will accrue interest faster than federal student loans.
For example, federal unsubsidized Stafford loans have a 4.29% interest rate. Private student loan rates range from 2% all the way up to 12% or more. Most private student loan borrowers fall somewhere in the middle of this range.
The Benefits of Paying Student Loan Interest in School
Paying accrued interest in school will save you money. A lot of it.
For example, the average student loan borrower had about $30,000 in debt upon graduation this year. Say that graduate didn’t pay any of his student loan interest during his four-year education. This unpaid interest accrued and was added to the principal of the loan.
Assuming a 6.5% average interest rate and monthly capitalization, this graduate will expect to pay about $4,300 extra during the life of his loan. This is in addition to regular principal and interest payments.
And the more debt you have, the greater the cost of capitalized interest. So, how do you pay accrued interest in school?
Great question. In fact, most private student loan lenders offer an interest-only payment option for students in college. You can choose to be billed for your accrued interest each month (approximately $100-150). Some lenders even offer special discounts for students willing to pay their interest in school.
I was able to lower my interest rate by 0.50% because I chose to make interest-only payments. Even small savings can add up to thousands of dollars over the life of the loan.
When it comes to federal student loans, it’s a little trickier. Depending on your loan servicer, you will need to make interest payments in different ways. Today, most federal student loan servicers will allow you to schedule recurring electronic payments. Simply calculate your monthly accrued interest, and set up a recurring payment for this amount.
Not only does paying interest in school get you a lower interest rate, it will also save the average student thousands of dollars over the life of the loan. That money could be put toward a car payment, mortgage or even spring break in Cancun!
Creative Ways to Earn Money to Pay Student Loan Interest
Making interest payments in college isn’t easy, nor fun. On the 14th of every month, I watch my bank account get a little lighter.
But I know I’m helping my future self, and I’ve managed to pay my interest each month since the spring semester of freshman year.
I know, I know: You’re a broke college student. Who isn’t? Here are a few ways I’ve managed to pay my student loan interest.
I worked at the finance computer center my freshman year of college. Many on-campus jobs can pay $9 an hour or more for work that feels like study hall.
Moreover, managers are usually students, too, and understanding your need to schedule work around your classes and other commitments.
Don’t stop applying for scholarships once you’ve entered school. Too many students believe scholarships are simply for incoming freshman and new students, which is a myth.
Scholarships exist for everything under the sun. Look for ones related to your degree, your passions and yourself. Here’s a list of 100 scholarships to get you started — plus another list of 100 more unusual options.
Freelancing or Online Jobs
I’ve always loved investing and finance, and I found three different financial media companies willing to pay me to write about my passion. Over the course of my college career, I’ve probably written well over 200 financial articles for freelance writing jobs.
Writing not your talent? Try one of these other online jobs for college students.
Simply put, paying your student loan interest in college sucks.
But at the end of the day, you can save yourself thousands of dollars if you bite the bullet and pay your accrued interest each month.
Your Turn: Would you consider making interest-only payments on your student loans? What are some other creative ways you’ve paid down debt as a student?
Nate Matherson is a student loan borrower. He is also the Co-Founder and CEO of LendEDU, a marketplace for student loans and student loan refinancing. LendEDU helps borrowers find the best student loan quotes in one place. LendEDU works to create transparency in the student loan market.