Since the 1990’s, student loan interest rates have hovered around 7%. They go up or down depending on the state of the economy. Currently they’re around 6%. But, there are ways you can lower your interest rate over time with a little careful planning.
This article will help you understand the details of interest rates and what you can do to reduce the cost of your loans in the long run.
What is your interest rate and how is it determined?
Any student loan you take out, both public and private, will carry some level of interest which you will eventually have to pay.
The interest rate is essentially the cost of borrowing, and it increases the longer it takes you to pay off your loan.
The interest is calculated as a percentage of the balance you have yet to pay. For government loans, the interest rate is set by Congress.
Your interest rate will vary based on a couple of different factors:
- The type of loan
- Whether the loan is public or private
- Whether the loan is fixed or variable interest
In order to calculate interest on your student loans, use this simple equation: Multiply your remaining balance amount by the number of days since your last payment, then multiple by the interest rate factor (change the percentage to a decimal, so for example 5% interest would be a multiplying factor of .05).
Interest Rates for Public vs Private Loans
Interest rates of private student loans are almost always higher than (public) government loans. A private loan is any loan which is not given by the Department of Education, such as loans from private banks or student loan companies.
The average interest for a private student loan ranges from 9-12%.
However, members of credit unions can get private loans for as low as 5%, which rivals government interest rates. But, not many young people these days are members of credit unions.
A public loan is any type of loan given by the Department of Education. There are many different types of loans which fall under this category:
- Perkins Loans have a fixed interest rate of 5%. These are given to undergraduate and graduate students who have been determined to have “exceptional financial need.” Instead of being disbursed by the government, these are actually disbursed from the institution you attend.
- A direct subsidized loan is given directly from the government and has an interest rate of 3%. This is down significantly from a decade ago where the interest rate was actually twice as high.
- Direct Unsubsidized loans have the same interest rate.
- Subsidized federal Stafford loans carry an interest rate of 5.6%. These are the most common type of student loans.
- Unsubsidized federal Stafford loans have an interest rate of 6.8%.
- Direct PLUS loans, given to parents and to graduate students, have an interest rate of 6.84%.
Subsidized vs Unsubsidized Loans: What’s the difference?
The difference between federal subsidized loans and federal unsubsidized loans is pretty simple. However, it is a pretty importance distinction for understanding how much interest you will eventually have to pay on your loans.
Subsidized loans are supported via a government agency by grant contribution. In simpler terms, this means that the cost of the loan is partially paid for by the government, and therefore these loans are primarily reserved for low-income students. As long as you are enrolled in school at least half-time, the government pays the interest on your loans.
Unsubsidized loans are money borrowed from the government, but not supported by the government. In other words, you accrue interest while you are in school, even if you are still in your grace period. You just have to pay that interest off later on. These are generalized loans and they are not given on the basis of financial need, so you will be expected to pay off the loan in full eventually.
The subsidized loans where the government helps you out by paying your interest are reserved for students with high financial need. It has been determined that their families will not be able to pay or lend them money to attend school without government assistance.
What is a student loan grace period?
The grace period also differs in some key ways depending on whether you have a subsidized or unsubsidized loan.
The grace period is six months after you graduate or stop attending school full time.
For subsidized loans, even though the government is paying your interest, you will begin having to pay it after the grace period, as well as making principal payments.
For unsubsidized loans, you do not have to pay interest or principal during the grace period either, but it is best to start paying off your loans as soon as possible. This is because your interest is building up during the whole time, including when you are in school. So the cost of all that interest will be added to your final balance. Don’t forget that you will be steadily accruing more interest the longer you wait to begin paying.
What is Amortization and How will it Affect you?
Amortization is paying back a loan of a fixed amount by making the same monthly payment each month. This is the way student loans are paid off, but the amount going towards interest or the principal changes over time. The kicker is that during the beginning of the repayment period, most of the payments you make are put towards paying the interest on the loan. This means that barely anything you pay goes towards the principal. This causes your interest to build up even more over time, and for you to pay more in the longer run.
The two ways to avoid amortization on your loan and pay less overall are:
- Make higher monthly payments. This is the best solution for paying less interest on any loan. However, it is not always feasible. Especially for a student fresh out of college without a steady, high-paying job.
- Lower your interest rate over time so less of your payment will go towards interest. This is difficult at times, but there are many strategies for achieving this.
How do you make sure you have the lowest possible interest rate on your loans?
There are five major strategies for reducing your interest payments on student loans:
- Refinancing your loans for a lower rate
- Consolidating multiple loans into one loan
- Pay them off using a lower-interest credit line
- Borrower Benefits
What is autopay?
By automating your repayment, you can save money and stress by making sure you never miss a payment. If you enroll in autopay, money to pay your student loans will come automatically out of a bank account whose information you give to your lender. Most common student loan lenders offer this option.
Make sure that the repayment plan will work with your financial situation before you enroll. If you sign up for autopay and then have to cancel it because you cannot maintain the monthly payments, you may risk spending a lot of money on the cancellation fees.
The biggest benefit of autopay is that almost every lender (with some exceptions in the private sector) will grant you a .25% interest rate reduction if you sign up for autopay.
They can do this because they know they will be getting their money back in a timely manner. It is also a great way to make sure you are not spending too much time putting off loan repayment, since you literally have to make a payment each month.
Refinancing and Consolidation
Refinancing and consolidation go hand in hand when trying to lower your interest rate. The first step is to contact your lender. Public student loans still go through a lending company, so you should contact them rather than the Department of Education or your university. The most straightforward way is to call the lender and ask about the potential for refinancing at a lower interest rate. They will look at your credit history and if you have been consistent in making payments on your loans and other credit lines, then they will likely grant you a lower interest rate or lower your monthly payments.
If that doesn’t work, the next step is to consolidate your loans. If you have multiple loans, which most students do, fold them all into one loan with a low interest rate. Keep in mind that public loans can only be consolidated with other public loans. Likewise, you can consolidate private with private. You cannot combine public and private loans. The process is different with each type. For private loans, you will have to contact your lender, as the process varies depending on who your lender is.
For public loans, you can apply for what is called a Direct Consolidation Loan. There is no fee to apply, and using this loan you can combine all of your loans. So you will only be making one loan payment each month. This saves you money by helping you avoid missing payments and also potentially giving you the option for lower interest rates and lower monthly payments, therefore extending the repayment period.
Using a lower-interest credit line
This is the least recommended of methods. That’s because it can be somewhat risky for your financial health to pay off a loan using another loan. However, if you are a member of a credit union or some private banks, they often will offer you a lower interest loan to use to pay off your student loans. Then, you pay off the loan and essentially transfer your balance to a new institution which you will owe monthly payments at a potentially lower interest rate.
It is never recommended that you open a credit card in order to make student loan payments. This is because after the introductory period is over credit cards usually carry a much higher interest rate than your initial loan itself.
Using Borrower Benefits
Many lenders, both public and private, offer borrower benefits to make their company more competitive in the market. Research your specific lender and ask which benefits they may offer. The most common is loan discounts. Companies offer reductions in interest rates after a certain number of successful on-time payments, usually after a few months of repayment.
Your interest rate could decrease by as much as 4% annually if you exhibit good repayment behavior.
Sometimes lenders also offer Graduation Credits of up to $1000 when you graduate or enter the repayment period. Finally, some lenders will forgive the last five or six payments at the end of the repayment period. Or they will forgive the rest of the loan balance when it falls below $500 or $600.