At a staggering $1.2 trillion, it’s no secret that student-loan debt is one of the largest crises facing our nation today. The New York Federal Reserve released some alarming information on student-loan defaults. The report revealed that up to 25 percent of all borrowers in the last nine years have defaulted on their loans, and 37 percent have missed at least one payment.
Outstanding interest is one of the major reasons why federal student-loan borrowers have defaulted on their loans. It’s important to note the amount of interest that accumulates on your loan from month to month.The interest rates on Federal Stafford loans are fixed, meaning that they do not change over the life of the loan.
Current interest rates for the 2014–15 academic year are 4.66 percent for subsidized and unsubsidized Federal Stafford loans to undergraduate students, and 6.21 percent for unsubsidized Federal Stafford loans to graduate and professional students. The interest rates on federal student loans are set by Congress.
Interest accrues on your student loan daily from the day it’s disbursed to the day it’s fully paid off. To calculate your daily interest accrual, you can use this simple formula:
Interest rate × current principal balance ÷ number of days in the year = daily interest
On subsidized loans, your interest does not accrue while you’re in school. However, interest on unsubsidized loans will begin racking up from the moment you sign on the loan and it is disbursed. If you don’t pay this interest while you’re in school, it’ll start to add on to the loan’s principle, and this process is called capitalization. In simple terms, this means that you’ll be paying interest on the total of what you borrowed on top of the interest that builds up while you’re in school.
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Here is an example of how it works:
Freshman year you borrow $10,000 at an interest rate of 5 percent. Your daily interest will be $1.37. By the time you graduate in four years, what you owe would grow from $10,000 to $12,000—an increase of $2,000.
$10,000 x 0.05 ÷ 365 = $1.37 daily interest.
$1.37 x 365 x 4 = $2,000
Sophomore year you borrow $15,000 at an interest rate of 5 percent. Your daily interest will be $2.05. By the time you graduate in three years, what you owe would grow from $15,000 to $17,245—an increase of $2,245.
$15,000 x 0.05 ÷ 365 = $2.05 daily interest
$2.05 x 365 x 3 = $2,245
Junior year you borrow $5,000 at an interest rate of 5 percent. Your daily interest will be $0.68. By the time you graduate in two years, what you owe would grow from $5,000 to $5,500—an increase of $500.
$5,000 x 0.05 ÷ 365 = $0.68 daily interest
$0.68 x 365 x 2 = $500
Senior year you borrow $10,000 at an interest rate of 5 percent. Your daily interest will be $1.37. By the time you graduate in one year, what you owe would grow from $10,000 to $10,500—an increase of $500.
$10,000 x 0.05 ÷ 365 = $1.37 daily interest
$1.37 x 356 x 1 = $500
If you didn’t pay the interest during your four years of school, by the time you graduate, you would have racked up an extra $5,245 onto your balance.
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If you receive a student loan, you will be required to repay that loan with interest. It is important that you understand how interest is calculated and the fees associated with your loan. Both of these factors will impact the amount you will be required to repay, and with tuition on the rise, knowing how interest works could save you from the consequences of a student-loan default.
—By Briana Supardi, special to CNBC.com