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student loan interest rates

Adulting Student Life

Understanding Student Loan Interest Rates

December 16, 2021

What Is Student Loan Interest?

Loans are not free. When you borrow money, you will not only have to repay the money you borrowed, but you will also have to pay interest to the lender.

The best explanation of interest is that it’s the cost of borrowing money. Whether you have federal or private student loans, you will be charged interest until the debt is completely paid off. Thus, when you are through the process of repaying the loan, you’ll pay back the original loan amount (known as the original principal) plus a percentage of the remaining balance (interest).

Private student loan interest rates range from approximately 1.04% APR (annual percentage rate) to 14.50% APR. Many private student loan lenders provide both fixed and variable interest rates, allowing qualified students to pick the option that best suits their needs. The interest rate you qualify for will be determined by your creditworthiness and, if applicable, that of your cosigner. On student loan lender comparison pages, you can quickly compare lender rates, terms, and advantages.

A simple daily formula or a compounding interest formula are commonly used to calculate interest. It’s essential to know the differences between these two formulas to understand how interest is calculated.

How Does a Simple Interest Formula Work?

Once you have a simple interest loan, also known as the simple daily interest formula, interest is calculated based on your remaining principal balance. This formula is used to calculate interest on all federal student loans. Some private student loans will also utilize the simple daily interest calculation formula, which you can find out in your loan’s terms and conditions.

How does the compound interest formula work?

In the case of the compound interest formula, the interest of your loan is calculated based on your interest rate to your principal (the original amount you borrowed) as well as any outstanding or unpaid interest that has been added to your loan. That is, the cost of your loan will be calculated based on both the original loan amount and any ongoing interest. Sometimes people refer to this as interest on interest.

How Is Student Loan Interest Calculated?

Let’s look at how student loan interest is calculated and how much your loan will cost. Federal student loans which can either be subsidized or unsubsidized loans mostly have fixed, low-interest rates. Whereas private student loans come from private lenders, each private loan will have its terms and conditions. While a private lender may use the simple daily interest formula, they may use a compound interest formula to determine the daily cost of your loan.

Simple Interest Formula

The simple interest calculator estimates an amount that includes the principal plus interest.

Simple Interest Equation (Principal + Interest)

A = P (1 + rt)

Where:

A indicates the Total accumulated Amount (principal + interest)

P indicates the Principal Amount

r indicates the Rate of Interest per year in decimal; r = R/100

t indicates the Period (months or years)

Compound Interest Formula

To use the compound interest formula you need to know the principal amount, annual interest rate, time factor, and the number of compound periods. Once you have all figures, you can calculate the compound interest.

The formula for compound interest, including principal sum, is:

A = P (1 + r/n) (nt)

Where:

A indicates the future value of the investment/loan, including interest

P indicates the principal loan amount

r indicates the annual interest rate

n indicates the number of times that interest is compounded per unit t

t indicates the time the money is invested or borrowed for

Understanding how interest works while repaying student loans may go a long way toward lowering your borrowing expenses, whether for student loans or any other sort of loan you may take out in the future.

BIO: Robert McMillen is an entrepreneur, finance professional, consultant, and passionate writer at Instant Loan Online. For many years using his industry knowledge and experience he has helped his clients to create more wealth and reduce costs.