Question 1

What is interest?

Accepted Answer

Interest is the monetary or extra charge you pay a lender in return for borrowing money. This expense is a percentage of a loan’s unpaid principal amount.

Interest is categorized as a simple one if it’s based on the loan’s principal amount. It’s called compound interest if it’s based on the principal and the loan’s previously earned interest.

Question 2

What increases your total loan balance interest accrual or interest capitalization?

Accepted Answer

Typically, loan balances decrease over time as you make repayments. However, student loan balances can increase even if you repay the debt.

In fact, research by Moody’s says almost half of student loan borrowers are further in debt five years after they begin paying back their loans.

This is mainly because of capitalized interest on student loans. This is unpaid interest that typically gets added to your student loan balance after periods when you don’t make payments—such as during deferment or forbearance.

Here’s a deep dive into these scenarios and other possible factors—

1. Paying less than the requested amount

You’ll have to pay a set amount of monthly payments to offset your student loan. But what if you pay less than the amount requested?

To begin with, your monthly payments won’t cover the loan’s interest and principal. This is because a portion of each installment is allocated towards clearing the interest and another towards the principal. Unpaid interest and principal will almost certainly increase your loan balance.

To understand how this affects your loan balance, we’ll use our free student loan debt snowball calculator. Assume you’re required to make a minimum payment of $30 on a $2,000 student loan. Here’s what happens to your balance over time:

Now, let’s assume you make a partial payment of $10. This will lead to an increased loan balance that’s more than the initial $2,000 loan amount.

2. Delays in loan repayments

Late loan payments incur penalties and costs. These fees are added to your initial loan amount, raising your total loan sum.

What happens if you miss a federal student loan payment?

30-day delay: As a late fee, your loan servicer may charge you up to 6% of the amount of your missed payment. For example, if you miss a $100 payment, you may be charged a $6 fee.
90-day delay: Your servicer may report late payments to credit bureaus. This may significantly lower your credit score.
270-day delay: your student debts will default. This may result in further penalties, such as collection expenses and the confiscation of tax refunds. You should be aware that collection fees might amount to up to 25% of the principal and interest as collection fees.

What about private student loans, though?

Unlike federal loans, private loans aren’t standardized. For instance, a lender’s late fee could be a percentage of your payment or a flat fee. Private lenders typically report late payments after 30 days. Plus, these loans default earlier than federal loans.

A MeasureOne study says the early-stage (30-89 days late) and late-stage (90 days or more) delinquencies for private student loans are 2.73% and 1.75%, respectively.

While these figures look encouraging, experts warn that student loan delinquencies may rise to pre-pandemic levels once federal student loan payments resume.

3. Choosing an extended payment plan

Extended payment plans are student loans that are typically repayable over 20 years or more. These payment options gradually reduce the loan balance.

But don’t these plans let you make smaller monthly payments?

Yes, they do. However, they can be costly in the long run. After all, the longer the payback time, the more interest you’ll pay. So, a ten-year loan will cost more than a five-year loan.

Furthermore, the tiny payments you make on extended plans only cover the interest and a portion of the principal. This means, skipping a payment will likely increase your loan balance.

4. Missing or deferring payments

You can miss a payment on an agreement with your lender. However, this doesn't mean that your loan balance is no longer accumulating interest. This interest is added to your principal, eventually increasing your loan balance.

Here’s an example:

Lenders can give you a six-month grace period after finishing your studies to make payments. This can help you get a job and build a source of income—but your student loan continues accruing interest during this time, resulting in a higher loan balance.

5. Income-driven payment plans

Income-driven payment plans often have the lowest monthly loan payment of any repayment plan.

Your monthly payment is determined using:

Your annual income.
The poverty line based on your family size.
Your state of residence.

You may find yourself in a scenario where you miss a payment or pay less than the minimum amount due each month. And because the monthly payment is less, this can increase your loan balance.

6. Calculation errors

Unusual calculation errors might sometimes boost your loan debt.

Wondering how to detect such errors? If you’re making the correct loan repayment and still notice your loan balance shooting up, query it.

Such errors can occur for a variety of reasons, including algorithmic problems, incorrect payment amounts, or combining your account with someone else’s.

Question 3

When do you start paying interest on student loans?

Accepted Answer

Student loans begin charging interest the moment they are disbursed. That implies your loan sum is already rising, even if you don’t start repaying it until you graduate.

As you approach your repayment period, your loan servicer will capitalize the previously accrued interest.

What does this look like in practice?

Assume you borrow $5,000 in student loans for your final year. And your loan won't be due for another six months after you graduate. This implies that interest will be charged on your loan for the next 18 months.

If you have a 5% interest rate, your monthly interest will be around $25. An additional $432 will be added to your balance over 18 months. Instead of the original $5,000, you’ll now owe your lender $5,432 in interest.

Question 4

What are the available options for student loan repayments?

Accepted Answer

Federal loans and most private student loans come with a grace period that’s usually six months long. While private and unsubsidized loans continue accruing interest during this time, you don’t have to make repayments yet.

Use this grace period to choose a student loan repayment plan that works best for you. Note that you can change your federal student loan repayment plan as often as you need to. Some private lenders also have alternate payment plans you can check out.

Wondering what is the best way to pay off student loans?

Here’s a look at some options for student loan repayment plans:

Standard repayment plans: the most common repayment plan that features scheduled payments and fixed monthly payment amounts. Federal loans usually have a repayment period of 10 to 30 years. This figure may vary for private loans.
Graduated repayment plans: available for all federal student loan borrowers. Here, payments start low and increase gradually over time. However, the loan must be repaid within 10 years.
Income-based repayment plans: you can qualify for an income-based repayment plan if you have a high debt relative to your income. Under this plan, monthly payments are either 10% or 15% of your discretionary income. Payments are evaluated each year based on your family size and income. Note that these are federal-only plans.
Extended repayment plans: federal-only payment options for direct loan borrowers with over $30,000 in outstanding loans. Here the monthly payments are low, and the time frame for repayment is within 25 years.

Question 5

What are two ways that can help you keep a budget while trying to reduce debt load from loans?

Accepted Answer

Here are some top tips on how to reduce student loan debt while keeping a budget:

Track your income and expenses so you can identify areas where to cut back and save money.
Look for ways to increase your income, such as taking on a side hustle or gig work.
Use the debt snowball method to pay off your smallest debts first while making minimum payments on your larger debts. This strategy can help build momentum to continue paying off your debts.
Negotiate with creditors for new payment terms or interest rates.
Consider debt consolidation to simplify your payments and lower your interest rate.
Reach out to a financial advisor or credit counseling service for help creating a plan to pay off your debts.

Question 6

Why does the amount of interest you owe decrease every month?

Accepted Answer

As you make monthly payments on your loan principal, the amount of interest you owe decreases.

When you borrow money, the lender charges you interest to earn a profit. The interest is usually calculated as a percentage of the loan amount and is added to your outstanding balance each month.

As you make payments on your loan, the amount you owe reduces, resulting in lower interest rates on the remaining balance.

The interest paid on the remaining balance will continue to drop each month as you pay down your debt. This means a bigger portion of your payment will go toward paying down the loan’s principal rather than interest charges.

Question 7

How to pay off private student loans?

Accepted Answer

We’ve discussed in length how to pay federal student loans. But how do you reduce your total loan cost if you have a private loan?

These loans usually have higher interest rates, and the borrower’s credit history and income are significant factors in determining the loan’s interest rate.

Here are some tips on how to lower student loan payments:

Contact your loan servicer to discuss alternative payment plans or deferment and forbearance options.
Consider refinancing your private education loans to get lower interest rates or monthly payments.
Consolidating your private education loans into one loan can help you lower your monthly payments. But this may increase the amount of interest you pay over the life of the loan.
Create a budget to manage your finances and prioritize your loan payments. Consider cutting back on expenses.
Seek financial counseling from a reputable organization. They can help you create a plan to manage your debt and improve your financial situation.