Student loans are a common way for many people to finance their education, but they come with one big downside: interest. The interest is the price you pay for borrowing money, and it can significantly increase the total amount you owe over time.
Whether you're dealing with federal or private student loans, understanding how interest works is essential for managing your debt.
In this article, we’ll break down exactly how student loan interest rates work—from how they’re calculated to when they accrue. We’ll also provide practical tips to reduce your interest payments, so you can save money and pay off your loans on time.
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How does student loan interest work?
Student loan interest is the cost you pay to borrow money for your education. It’s essentially a percentage of your loan balance that lenders charge on top of the amount you initially borrowed, and it can drastically affect how much you end up paying over time.
There are two types of interest rates on student loans—fixed and variable:
- Fixed interest rates stay the same throughout the life of the loan, offering predictable monthly payments and overall loan costs.
- Variable interest rates fluctuate based on market conditions. While they may start lower than fixed rates, they can increase over time, potentially leading to higher payments.
Fixed rates are more stable, but variable rates may be appealing if you're willing to take on some risk for the chance of lower initial payments.
The type of loan—whether federal or private—also influences how interest is determined.
- Federal student loans—both subsidized and unsubsidized—have fixed interest rates, which are set by the government (currently going from 5.50% to 8.05%) and are generally lower than private loans. These rates are determined annually based on the financial markets but once applied to your loan, they don’t change.
- Private student loans may have either fixed or variable interest rates, which the lender determines based on your credit score, financial history, and sometimes the loan amount.
When does interest start on student loans?
The timing of interest accrual varies based on the type of loan you have. “For most federal loans, interest starts adding up right after the loan is given out,” says Steven Kibbel, a financial advisor at Prop Firm App. “But there's a silver lining with subsidized federal loans. The government actually pays the interest while you're in school, during your grace period, and if you need to defer payments.”
Unsubsidized federal loans and private loans are a different story. Usually, the interest clock starts ticking immediately once you receive the loan.
How is student loan interest calculated?
The interest rate on student loans is typically calculated using a formula that depends on your loan's balance and interest rate. The basic formula for calculating daily interest is:
Daily interest = (loan balance x interest rate) ÷ 365
This method is called simple daily interest. It means that each day, the interest is calculated based on the remaining loan balance. The more you owe, the more interest you'll accrue each day. This interest is then added to your balance, increasing your overall debt until you make payments to cover both the interest and the principal.
The length of your loan term plays a significant role in how much interest you’ll ultimately pay. While longer repayment terms may lead to lower monthly payments, they can significantly increase the total amount you pay in interest over time. Shorter terms, while requiring higher monthly payments, help reduce the overall interest paid.
For example, a 10-year loan will accumulate much less interest compared to a 20-year loan, even if both loans have the same interest rate. This is why you should carefully consider your repayment plan and term length.
Example
Let’s break down a real-world example of how to calculate student loan interest rates. Suppose you have a loan balance of $20,000 with an interest rate of 5%.
- Calculate the daily interest:
Daily Interest = ($20,000 x 0.05) ÷ 365 = $2.74 per day - Determine the monthly interest:
Since there are about 30 days in a month, multiply the daily interest by 30.
Monthly Interest = $2.74 x 30 = $82.20
In this case, $82.20 is the amount of interest that will accrue in one month if no payments are made. This highlights why it’s crucial to keep paying off your loans consistently to prevent the balance from growing too fast.
Tax benefits for student loans interest rates
There’s a silver lining when it comes to paying interest on student loans. “You can potentially claim a deduction of up to $2,500 on your federal taxes for the interest you've paid on your student loans,” Kibbel says. “This applies to both federal and private loans, which is great. It's like getting a discount on your taxable income.”
However, not everyone qualifies for this deduction—it depends on your income levels and filing status. According to the IRS, to be eligible, your modified adjusted gross income (MAGI) must be below certain limits—currently, individuals with a MAGI of $90,000 or more (or $185,000 for joint filers) cannot claim the deduction. Additionally, if you are married but filing separately, you are not eligible for this tax benefit.
Kibbel recommends consulting a tax professional to ensure you're making the most of this benefit and reducing your overall tax burden effectively.
How to lower student loan interest
Managing student loans requires more than just making regular payments. Some strategies can make a big difference in the amount of interest you’ll pay. By being proactive and exploring your options, you can minimize your loan burden and pay off your loans faster.
1. Improve your credit score
Your credit score plays a significant role in determining your interest rate, especially for private loans—which is helpful whether you’re applying for a loan, or you plan to refinance an existing one. “Your credit score is like your financial report card, and it can make a big difference when negotiating better terms,” Kibbel says. A higher credit score signals to lenders that you're a reliable borrower, which can result in lower interest rates. Build your credit by paying bills on time, reducing debt, and keeping credit card balances low.
2. Refinance your student loans
Refinancing involves taking out a new loan to pay off one or more existing student loans. This new loan often comes with a lower interest rate, helping you save money on interest over the life of the loan. Refinancing can also consolidate multiple loans into one, making repayment simpler. However, it's worth noting that refinancing federal student loans into a private loan means losing federal benefits like income-driven repayment plans and loan forgiveness options.
3. Enroll in autopay
Setting up automatic payments for your student loans is one of the easiest ways to reduce interest rates. “Many lenders offer a discount, typically around 0.25%, just for setting up automatic payments,” Kibbel says. While the discount may seem small, over the life of a loan, it can lead to substantial savings. Monitor your account balance regularly to avoid overdraft fees, which could negate your savings.
4. Explore discounts and loyalty programs
Some lenders offer additional ways to save through loyalty programs or discounts for existing customers, Kibbel says. These programs are often underused, so check with your lender to see if you qualify. Even a small reduction in your student loan interest rate can help reduce your total payments over time.
5. Consider a co-signer
If your credit score or income isn’t strong enough to secure a low interest rate, a co-signer can help. A co-signer with a good credit profile can improve your chances of getting a lower rate or better loan terms. Be aware, though, that the co-signer is equally responsible for repaying the loan if you're unable to make payments.
Alternative strategies for student loan payments
When managing payments, look beyond just lowering your student loan interest rates. Several alternative strategies can help reduce your monthly payments or total loan cost, offering greater flexibility and control over your debt.
Income-driven repayment plans
For federal student loans, income-driven repayment plans (IDR) can be a lifeline for borrowers struggling to keep up with their payments. These plans adjust your monthly payment based on your income and family size, often reducing payments to a manageable level. While IDR plans lower monthly payments, they can extend the loan term, which means more interest accrues over time.
However, any remaining loan balance is forgiven after 20 or 25 years, depending on the plan. The key is understanding that while your monthly payment might be smaller, the total amount you pay could be higher due to the extended repayment period.
Loan forgiveness programs
Loan forgiveness programs are designed to cancel part or all of your student loan debt after meeting specific conditions. “They can be a game-changer for many borrowers,” Kibbel says. “They can dramatically reduce the total amount you pay over the life of your loan by canceling part or all of what's left after a certain period.”
For instance, Public Service Loan Forgiveness (PSLF) cancels your remaining federal student loan balance after you make 120 qualifying payments while working for a qualifying employer, such as a government or nonprofit organization.
However, there is fine print with loan forgiveness programs. “Until recently, forgiven amounts were often treated as taxable income, which could lead to a surprise tax bill,” Kibbel says. Luckily, recent changes to legislation have made most forgiven loan amounts tax-free through 2025, offering an even greater financial benefit for qualifying borrowers.
Making extra payments
If you're in a position to do so, making extra payments on your student loans can be one of the most effective ways to minimize interest. By paying more than the minimum monthly amount, you reduce the principal balance more quickly, which in turn decreases the amount of interest that accrues over time. If you receive a bonus, tax refund, or other unexpected income, consider putting it towards your loan to knock down your balance faster.
But first, check with your lender to confirm that your extra payments are applied to the loan principal and not just future payments. This strategy is especially useful for private loans that may not offer the same flexibility as federal loans when it comes to repayment plans and forgiveness options.
FAQs
Do student loans have interest?
Yes, all student loans have interest. Federal student loans come with fixed interest rates set by Congress, while private student loans can have either fixed or variable rates determined by the lender. The interest on these loans is what makes borrowing money costly over time, as it adds to the total amount you'll need to repay.
How to avoid interest on student loans?
While you can't completely avoid interest on student loans, there are ways to reduce the amount of interest that accrues. For federal subsidized loans, interest does not accrue while you're in school, during your grace period, or if you defer payments. For other loans, making payments while you're still in school or paying extra toward the principal can help minimize the total interest you’ll owe over time.
How does interest accrue on student loans?
Student loan interest accrues daily based on your loan's principal balance. The formula typically used to calculate daily interest is: (Interest rate ÷ number of days in the year) x outstanding principal balance = daily interest. This daily interest is then added to your loan balance, which increases the total amount you owe.
For unsubsidized loans, interest accrues from the moment the loan is disbursed, while subsidized federal loans have specific terms that delay interest accrual.
How much student loan interest can you deduct?
You may be eligible to deduct up to $2,500 in student loan interest on your federal taxes each year. This deduction applies to both federal and private loans and reduces your taxable income, potentially lowering your overall tax bill. However, there are some limitations—your eligibility depends on your modified adjusted gross income (MAGI) and filing status: Currently, individuals with a MAGI of $90,000 or more (or $185,000 for joint filers) cannot claim the deduction.
How to lower my interest rate on student loans?
There are several strategies to lower your student loan interest rate. One common approach is to refinance your loans, which can result in a lower rate, especially if your credit score has improved since you first took out the loan. Additionally, signing up for automatic payments often qualifies you for a 0.25% interest rate reduction. Having a good credit score and, if possible, applying with a co-signer are also effective ways to secure better rates.