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Student Loans

How Does Student Loan Interest Work?

For undergraduates, the student loan interest rate for Direct Unsubsidized and Subsidized loans is now 4.99%, and the rates are higher if you’re pursuing a graduate degree. 

Understanding student loan interest is crucial to avoid taking on too much debt and to pay down what you owe. 

This guide will show you how student loan interest is calculated, the different interest rates available, and provide tips to get the lowest possible rate on your loans.

In this guide:

How does student loan interest work?

Student loan interest rates are based on three main factors:

  1. The amount borrowed
  2. The type of loan
  3. The estimated time it takes to repay 

Interest rates vary by lender, so borrowers should shop around and compare rates before taking out a loan.

You’ll get your interest rate when you apply for a federal or private student loan. This rate is the annual percentage rate (APR), which is the actual yearly cost, including interest and fees, for the loan term. 

Federal student loans have fixed interest rates which Congress sets. Private student loans can have either a fixed or variable APR, and your lender determines your rate.

Check out the main differences in the table below:

Fixed rateVariable rate
Remains the same for the life of the loan.Changes with its underlying market index.
Makes budgeting for payments easy.Could rise or fall based on market rates.
Can change as often as every month, but typically changes every 6 – 12 months.

Depending on whether interest accrues daily or monthly, the interest your loan generates is tacked onto your total balance each day or month.

The balance includes the principal (initial borrowed amount) and interest accrued. You must repay the interest before paying down the principal balance, so not paying makes your debt more expensive over time.

How do interest rates differ between federal and private student loans?

Interest rates are often lower on federal student loans than private student loans. Federal student loan interest rates are fixed for the whole loan period and may not exceed the maximum rates listed in the Higher Education Act of 1965:

  • 8.25% – Direct Subsidized Loans and Direct Unsubsidized Loans for undergraduates
  • 9.50% – Direct Unsubsidized Loans for graduate or professional students
  • 10.50% – Direct Parent PLUS loans

These are the maximum allowed rates for federal student loans, but often the rates are much lower. For example, federal student loan interest rates range from 4.99% to 7.54% for 2023.

Loans from private student lenders have no maximum limit, and variable interest rates can balloon to be much larger than the initial interest rate of your loan. In 2022, private student loan rates varied from 3.99% to 15.66%. 

It may seem best to choose the loan with the lowest interest rate, but also consider the other terms of the loan. Variable interest rates may start out lower than fixed rates but are subject to change, which could increase your monthly payment. 

More flexible repayment options are available for federal student loans, including income-based repayment plans and deferment. These options are not available for many private loans.

How often does student loan interest compound?

Compound interest is the addition of interest to the principal of a loan—interest on the interest. Most student loans accrue interest daily and compound daily or monthly.

Daily compounding means your APR applies to the interest that accrued the previous day. This is in addition to the rest of your principal amount. 

Compared to monthly, daily compounded interest is less advantageous for you because the more often your interest compounds, the faster your debt will grow. 

In most cases, student loan rates are advertised with yearly interest rates (APR), but the interest compounds daily. You can find out how often your interest accrues as well as your compounding rate on the promissory note for your student loans.

How to calculate student loan interest

Using the simple daily interest formula, you can calculate your interest the following way.

Begin by determining your interest rate factor using the following calculation:

Fixed interest rate of your loan / Number of days in a year = Interest rate factor

Then multiply the following:

Principal balance x Interest rate factor

Let’s assume you take out a $10,000 student loan with a 5% APR. 

The interest rate factor is 0.0137% (0.05 / 365 = 0.000137). 

Here’s what your interest would look like with daily compounding compared to monthly compounding:

Daily compoundingPrincipal x Interest rate factorTotal principal + interest
Day 1$10,000 x 0.000137$10,001.37
Day 2$10,001.37 x 0.000137$10,002.74
Day 30$10,039.81 x 0.000137$10,041.18

In this example, $41.18 of interest has accrued in a month.

Monthly compounding
Principal x Interest rate factor x Number of daysTotal principal + interest
$10,000 x 0.000137 x 30$10,041.10

Over a month, $41.10 of interest has accrued.

As you can see, daily compounding results in slightly higher interest charges over a month. 

The difference will be insignificant if you make monthly payments that cover all the interest that has accrued that month. 

But if you don’t keep up with your payments, the interest that accrues each day will continue to grow as the daily interest adds to your principal balance. It’s important to meet your repayment obligations on time and in full each month because it will help minimize your total debt burden over the long term.

When does student loan interest start accruing?

You will start accruing interest at different times depending on the type of loan you take out. 

In some cases, interest begins accruing upon disbursement. This is always the case with private student loans and federal Direct Unsubsidized Loans. If you don’t make interest payments while in school, the interest will accrue throughout your years in college.

In the case of federal Direct Subsidized Loans, the federal government covers your accrued interest while you are in school and over a six-month grace period after you graduate. Once those six months are up, you are responsible for repaying the principal and the interest.

Type of loanBorrower type Fixed interest rate (as of January 2023)Start of interest accrual
Direct Subsidized Loans Undergraduate4.99%6 months after graduation as long as you are enrolled at least half-time
Direct Unsubsidized LoansUndergraduate4.99%Upon loan disbursement
Direct Unsubsidized LoansGraduate or Professional6.54%Upon loan disbursement
Direct PLUS LoansParents and Graduate or Professional Students7.54%Upon loan disbursement

Federal student loans

You don’t have to start paying student loan interest right away

Even for most unsubsidized loans, such as those from private lenders, you won’t have to start paying interest immediately. Many private companies allow for a grace period, which can be excellent news for students who can’t take on a job during college.

Under certain circumstances of financial hardship, such as a period of unemployment or reduced income, borrowers can work with their lenders to enter deferment or forbearance and temporarily freeze or decrease their monthly payments. 

This action helps the borrower avoid default when money gets tight.

ForbearanceDeferment
DefinitionLoan repayment relief that allows you to temporarily reduce or freeze payments on student loans if you are experiencing a financial hardship.Temporary suspension or reduction of your monthly loan payments.
DifferenceInterest continues to accrue and is added to your principal balance when your forbearance ends.You will not have to make any principal payments on your loans.

However, you must pay interest on Direct Unsubsidized, Direct PLUS, Federal Family Education Loan (FFEL) PLUS, the unsubsidized portion of Direct Consolidation, and the unsubsidized portion of FFEL Consolidation loans

Regardless of these options for postponement, keep this in mind: Once you receive an unsubsidized loan, if you forgo payments through the six-month grace period after you leave school, you might already owe thousands more than you borrowed.

In this case, it will take several payments before you begin paying down the principal.

How to pay off the interest on student loans faster

The faster you pay off your student loan interest, the faster you can start paying off your principal balance, which will reduce your interest over time. 

If you’re tired of paying interest on your loans, here are the steps to paying off your loans early.

Prioritize your loans

One way to pay off your student loans faster is to prioritize your loans by interest rate. 

Once you’ve established your payment schedule with automatic payments of at least the minimum required amount, allocate any remaining resources to the loan with the highest rate.

You can see an example of this in table below:

Example prioritization
Payoff orderLoanBalanceInterest rate
1Loan B$10,0007.80%
2Loan C$3,0006.50%
3Loan A$5,0004.99%

Make extra payments

We recommend making extra payments whenever possible—especially if your interest compounds daily. A second monthly payment helps minimize the amount of time interest can accrue while you pay down the principal.

A smart way to handle this is to make a payment every time you get paid (if you get paid every two weeks). Your first paycheck can cover the interest you’ve accrued in the previous month, and the second will eat away at the principal and limit the interest that accrues in the subsequent month.

For example, if you were paying off a $10,000 loan at 7.8%, you’d have a monthly payment of about $120. 

If you made two payments each month of $120, you would pay off your loan in four years instead of 10 and save $2,700 on interest:

Current2 payments per monthSavings
Repayment length10 years4 years6 years
Interest payments$4,433$1,700$2,731
Total cost$14,433$11,700$2,731

Calculate how an extra payment could save money on your student loans with our student loan prepayment calculator.

Refinance

Refinancing student loans is another smart way to abate the pileup of interest. If you think you might qualify, apply for a loan with lower interest rates from a private company, or check whether you can refinance through a state-run program.

Be aware that refinancing federal student loans with a private lender will forfeit any borrower protections you get with federal loans, such as eligibility for income-driven repayment or the potential for student loan forgiveness.

Take a look at how refinancing a $10,000 student loan with an 8% interest rate to a loan with a 5% interest rate could lower your monthly payments by just $15 but save you more than $1,800 over the life of the loan:

CurrentRefinanceSavings
Monthly payment$121$106$15 per month
Term length10 years10 years0 months
Total interest$4,559$2,728$1,831
Total cost$14,559$12,728$1,831

Calculate how refinancing your student loans could save you money with our student loan refinance calculator

How can I lower my student loan interest rate?

Our additional tips for lowering student loan interest rates are as follows:

  • Refinance: If you have good credit and a steady income, you can refinance your student loans with a private lender or through your state at a lower interest rate.
  • Consolidate: Consolidate federal student loans into one monthly payment through the Department of Education’s Direct Loan Consolidation program.
  • Autopay discounts: Many loan servicers reward borrowers for setting up automatic payment plans. Check with your lender to see what discounts are available.
  • Get a cosigner: Having a parent or significant other with a high credit score attached to your loan can give a private lender peace of mind the money is in good hands, helping you qualify for a lower rate. Or if you have good credit but don’t make enough money to qualify for a lower interest rate, you can get a loan or refinance your loan with a cosigner who qualifies.
  • Improve your credit score: Making on-time payments each month can help you improve your credit score and increase your odds of qualifying for a lower interest rate for new or refinanced loans.  

These options offer a greater chance of paying down your student loan interest and then the principal sooner. 

Do your best to keep on schedule, get ahead when you can with additional payments, and remain aware of what you owe.