Can Your High Schooler Answer These 6 Interest Rate Questions?

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Our team at Student Loan Hero works hard to find and recommend products and services that we believe are of high quality and will make a positive impact in your life. We sometimes earn a sales commission or advertising fee when recommending various products and services to you. Similar to when you are being sold any product or service, be sure to read the fine print understand what you are buying, and consult a licensed professional if you have any concerns. Student Loan Hero is not a lender or investment advisor. We are not involved in the loan approval or investment process, nor do we make credit or investment related decisions. The rates and terms listed on our website are estimates and are subject to change at any time. Please do your homework and let us know if you have any questions or concerns.

student loan interest rates

Parents, you’ve probably started planning and saving for your child’s college education. But are you also preparing your high schooler to borrow responsibly for college?

Student loan interest rates are an important piece of the puzzle. If student loans are part of the plan to pay for your child’s college education, now is the time to start teaching your child how student loans work.

What to teach your high schooler about student loan interest rates

Your child should know what student loan rates are and understand the impact they’ll have on their costs and future. Every college-bound high schooler should be able to answer the following questions about interest rates.

1. What are student loan interest rates?

Start simple with how borrowing and interest work. A student loan is money you borrow and have to repay. That’s often done in monthly installments, which are more affordable than repaying the loan at once.

“It is imperative that a student understands loans are not free money but money that has to be paid back at a later time with interest,” said Ivette Chavez, the lead college financial services coordinator of the College & Alumni Program.

Make sure your student understands that, on top of their initial balance, they’ll pay fees, such as origination fees and other upfront costs, in addition to interest.

Student loan interest rates are sort of like price tags on student loans. They show how much your child will pay as they carry a balance on their student loans.

2. How do student loan interest rates work?

Student loan interest rates tell you and your child how much you’ll pay to borrow money for college. But it’s important to understand exactly how lenders use these rates to charge interest.

Federal student loans use simple annual interest rates, which don’t take into account compounding interest (interest you pay on accrued interest) or fees. While they’re written as annual rates, lenders assess and charge student loan interest on a daily basis.

To charge interest daily, lenders use a daily interest rate that’s calculated by dividing the annual interest rate by 365 (the number of days in a year). For an annual interest rate of 5.00%, for example, the daily interest rate would be 0.0137% — or $1.37 in interest per day if your loan amount was $10,000.

Interest charges are also compounded into the loan. So the next day, the 0.0137% daily interest rate would be charged on the new balance of $10,001.37.

It’s important to note that federal and private student loans use different kinds of rates. Federal student loans use simple rates, but most private student loan rates are written as annual percentage rates (APRs). These APRs include both fees and compounding interest. Learn more about how APRs differ from interest rates.

3. When will your student loan interest rate apply?

Students also should be aware that their student loan rates likely will take effect as soon as they take out a loan.

Most students choose to defer loan repayment until after college, but the interest you’re charged will be added to your student loan balance as soon as you take out the loan.

Keep in mind that student loans your child borrows early in their college career could cost more since they’ll accrue interest the longest.

4. What is a student loan interest subsidy?

Students who borrow through Direct Subsidized Loans receive a student loan interest subsidy. Interest on these loans is paid for by the Department of Education while you’re enrolled in school.

“Direct Subsidized Loans are the best option to finance a college education because they don’t accrue interest,” Chavez said. “This means the amount you borrow today will remain the same until you complete your degree. There is no interest added to your principal balance.”

You can apply for Direct Subsidized Loans and other federal student aid by submitting a Free Application for Federal Student Aid (FAFSA). If you qualify, using Direct Subsidized Loans first could save you hundreds of dollars in interest.

5. What is the interest rate on student loans today?

Most student loans fall into one of two main categories: federal student loans backed by the government and private student loans offered by banks and other lenders. Different types of student loans will have different ways of calculating and setting your interest rates.

Here are the interest rates on federal student loans for 2017-18:

  • Direct Subsidized Loans are federal student loans offered directly to students. They carry a one-time loan fee of 1.066% and interest rates of 4.45%.
  • Direct Unsubsidized Loans have the same terms as Direct Subsidized Loans but without an interest subsidy.
  • Parent PLUS Loans are available to parents of undergraduate students. They’re more expensive, as they charge a one-time fee of 4.264% and student loan interest rates of 7.00%.

Each student or parent who takes out a federal student loan pays the same student loan rates.

Private lenders, however, customize their rates based on the individual borrower’s credit score and loan terms. Your student will get better-than-average student loan interest rates on private loans only if they have excellent credit (or a cosigner who does).

6. Will your student loan interest rates change?

The short answer is yes. Federal student loan rates could change each year your student is in college.

Make sure your high schooler understands how student loan rates are set. All federal student loan rates are calculated based on rules written by Congress. Each year, these federal student loan rates are recalculated based on those rules, which can result in rates rising, falling, or staying the same. Last year, for instance, federal student loan rates rose by 0.69%.

However, while rates on new federal student loans can change each year, rates won’t change on your child’s existing debt. Federal student loans have fixed interest rates, which means they’ll remain the same throughout the life of the loan.

Similarly, most private student loan rates are based on general market conditions. If rates are rising in general (as they currently are), you and your child should expect to pay more each year to borrow with private student loans. If you choose a variable-rate student loan, you could see your student loan rates increase each month.

Understanding student loan interest rates is key to borrowing affordably for college. Learning about college costs, student aid, and loans can be a solid investment with big payoffs.

“As [high school students] make their college decision in the spring of their senior year, they will have the foundation to be able to make the best financial fit decision for themselves and their family,” Chavez said.

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Our team at Student Loan Hero works hard to find and recommend products and services that we believe are of high quality and will make a positive impact in your life. We sometimes earn a sales commission or advertising fee when recommending various products and services to you. Similar to when you are being sold any product or service, be sure to read the fine print understand what you are buying, and consult a licensed professional if you have any concerns. Student Loan Hero is not a lender or investment advisor. We are not involved in the loan approval or investment process, nor do we make credit or investment related decisions. The rates and terms listed on our website are estimates and are subject to change at any time. Please do your homework and let us know if you have any questions or concerns.