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Unlike credit cards, where you only incur interest if you carry a balance, student loans typically start to accrue interest daily once the loan is disbursed. (Exceptions are direct subsidized federal loans and the current suspension of federal student loan payments as part of Covid relief efforts that has stopped the additional accrual of interest while in effect.)
With student loan borrowers being charged interest every single day on top of the amount they already owe, their balances can balloon quickly. This is why it's important to do the math. Knowing the interest rate on your student loan(s) can be a big wake-up call about just how much your student debt is costing you.
For Melanie Lockert, personal finance blogger and author of the book, "Dear Debt," realizing that she was paying $11 a day in interest was what jump-started her journey to paying off nearly six-figure student loans.
To see how much interest you're paying every month — and how much you actually pay toward your loan balance — follow the steps below to calculate your own student loan interest:
For the example below, we use a 10-year standard repayment plan, an annual interest rate of 5.30% (the higher end of the average interest rate on federal student loans that ranges from 2.75% to 5.30%, at the time this article was written) and a $30,030 principal balance (how much the average public university student borrows to attain a bachelor's degree).
It gets a little granular, but bear with us. We've assumed that you're only making the minimum payments every month and that the interest rate is fixed (meaning it doesn't fluctuate).
Here's what to do:
Step 1: Divide your annual interest rate by 365 days to determine your daily interest rate, or the amount of interest that accrues on a daily basis. Using the stats above, the first calculation would look like such:
0.053 (annual interest rate) / 365 days in a year = 0.000145, or 0.015% in daily interest
Step 2: Multiply your daily interest rate by your principal balance to determine how much interest you're charged each day, or your daily interest amount. The second calculation would look like such:
0.000145 (daily interest rate) x $30,030 (principal balance) = $4.36 in daily interest
Step 3: Multiply your daily interest amount by the number of days in your billing cycle (we assume a 30-day cycle) to determine how much interest you're charged each month, or your monthly interest amount. The third calculation would look like such:
$4.36 (daily interest) x 30 days in billing cycle = $130.82 in monthly interest
In this scenario of an average public university student taking out a $30,030 loan with an annual federal interest rate of 5.30%, they would pay roughly $130.82 in interest alone each month. That's an estimated $1,569.84 in total interest for the year. Paying off your loans more quickly would reduce this amount over time.
The above calculation uses a standard repayment plan and simple interest, which is a fixed rate and calculated based on the original amount borrowed (also known as the "principal"). We've assumed this cohort of public university students are taking out federal loans since about 92% of all student loan borrowers have federal loans.
Keep in mind that while federal student loans charge simple, fixed interest rates that remain the same over the lifetime of the loan, some private student loans charge compound interest and have variable interest rates. This means that the daily interest rate may go up or down in the future and the interest is calculated on your principal amount, plus your accumulated interest — making your overall interest payments even higher.
Much of your monthly payment goes to the interest portion of your debt. Student loan servicers generally apply your monthly payment first to any fees you may owe, then to the outstanding interest and, lastly, to your principal balance.
With the loan amount, annual interest rate and 10-year repayment plan that we used in the example above, we calculated the estimated monthly payment to be about $323 (using Sallie Mae's student loan repayment calculator). With a $323 monthly payment (assuming no fees), $130.82 would go toward interest, leaving $192.18 to go toward principal.