Whether you’re an incoming freshman or a senior ready to graduate, it’s easy to view student loans as a solution to your current problem without any consideration for their terms.
But with the average student loan balance of $39,400 for Class of 2017 graduates, it’s essential that you understand what you’re getting yourself into — specifically, student loan interest rates.
Read on to learn everything you need to know about interest rates on student loans and how they impact your balance.
What are student loan interest rates?
When borrowing money to pay for college, lenders need something in return to make the deal beneficial for both parties. That’s where interest rates apply. They’re typically marketed as an annual percentage, but interest charges are added to your balance and paid monthly.
The APR on your loan will depend on a few factors and can even change over time, depending on whether you have fixed or variable interest rates.
How lenders determine student loan rates
Federal student loan interest rates are set by Congress and are tied closely to the 10-year Treasury note, plus an additional percentage.
Loan servicers aren’t able to set their own rates on federal student loans, and most loans have a fixed rate through the entire term. Interest rates are set each spring before a new school year.
Private lenders, on the other hand, determine their own student loan rates based on a risk-based pricing model. This means that they offer a range of interest rates, and the rate you receive when you get approved is based on how risky of a borrower you are.
Each lender has different criteria for determining interest rates, as well as varying rate ranges. Private lenders consider your credit history, income, and other factors when determining your rate. Private student loan rates can either be fixed or variable.
Average student loan interest rate
The average student loan interest rate depends on the type of student loan you get. Federal loans tend to charge lower interest rates for undergraduates, especially considering there’s no credit check as with private student loans.
But graduates and parents may find it worthwhile to compare federal loan rates with rates from private lenders.
Federal student loan interest rates, 2018-19
Federal student loan interest rates can change each year. Here are the interest rates you will pay for federal student loans during the 2018-19 school year.
|Loan type||Eligible borrowers||2018-19 rates|
|Direct Unsubsidized||Graduate and professional students||6.60%|
|Direct Graduate PLUS||Graduate and professional students||7.60%|
|Direct Parent PLUS||Parents||7.60%|
Average student loan interest rates from private lenders
Because private lenders can set their own rates according to their own underwriting standards, the average student loan interest rate is based on a wide range. To give you an idea of what to expect, here are a few top private student lenders.
|Lender||Eligible borrowers||Current rates|
|College Ave Student Loans||All students and parents||3.69% – 12.07%|
|Sallie Mae||All students and parents||4.12% – 11.85%|
|Citizens Bank||All students and parents||4.07% – 12.19%|
Learn more about these and other top private student loan companies to see if they’re a good fit for your needs.
How lenders apply student loan interest rates
Your student loan interest starts accruing the day you take out your loan. If you received Direct Subsidized Loans, the federal government pays your interest while you’re in school and during the six-month grace period after you leave.
But once that grace period is over, you become responsible for paying back both the principal and interest.
If you took out Direct Unsubsidized Loans, Direct PLUS Loans, or private student loans, interest accrues unpaid while you’re in school. If you don’t make interest-only payments, the accrued interest capitalizes and is added to your principal balance.
Going forward as you make payments, your student loan servicer will require you to pay off any late fees and accrued interest before applying any part of your payment to your principal balance.
Here’s how your interest gets calculated:
Interest Rate x Current Principal Balance ÷ Number of Days in the Year = Daily Interest
As an example, let’s say your current balance is $32,037 and your interest rate is 6.38%. Plug these numbers into the formula and you get:
6.38% x $32,037 ÷ 365 = $5.60 a day
The higher your balance and your student loan interest rates, the more interest will accrue on a daily basis.
How to reduce the interest you pay on your student loans
There are ways to reduce the amount of interest you pay over the life of your loans. The best way is to pay off your loans as quickly as possible. Since interest accrues every day, the faster you pay off your debt, the less interest will accumulate.
If you have unusually high interest rates on your federal loans, you can also potentially refinance them into a private loan at a lower interest rate. This can save you thousands of dollars over the life of your loan.
Take our refinancing eligibility quiz to see if it’s a good option for you.
Ultimately, the faster you pay off your loans, the better. Now that you understand how interest is calculated and added to your bill, you know how important it is to eliminate your student loan debt while paying as little interest as possible.
Cat Alford contributed to this article.
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