Student Loan Interest 101

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Do you have student loans, credit cards or are you paying off car loans or a mortgage? If you said yes to any part of that question, here is another one: do you know how much you are paying in interest each month?

Three-quarters of young adults ages 22 to 35 report they carry some type of debt, according to Money Under 35, a study conducted by Navient and Ipsos. Credit cards and student loans are the most common types, held by 37 and 34 percent of young adults, respectively.

Understanding how the components of a loan function, and how loan interest can affect how much you pay on your loan in particular, is key to paying off your loans on time and improving your financial health. Let’s take a look a closer look at how interest affects your loan.

Generally, a loan is broken into three main components:

  • Principal: This is the total sum of money borrowed, in addition to any unpaid interest that is “capitalized,” or added to the original amount borrowed.
  • Interest: Interest is the fee charged by the lender for the use of borrowed money. Interest is calculated as a percentage of the principal that you haven’t yet repaid, and depending on the type of loan, is calculated at either a fixed or variable rate.
  • Fees: Borrowers can sometimes pay extra fees for taking on a loan, including an up-front fee, such as an origination fee, or late fees if they are late on their payments.
Exhibit 2: Understanding How Interest Works

A loan’s interest rate and any accompanying fees are typically spelled out in the loan agreement signed prior to taking on a loan. For a student loan, that document is usually called a “promissory note.”

Repaying your loans on time and in full is important not only for keeping your credit score in check, but also for minimizing your interest costs. Here are three tips to help keep interest in check:

1. Be aware that your loan balance can grow while you’re in school.

You aren’t expected to pay back most student loans while you are still a full-time student, but interest can still be charged during this time. That means your balance will be more than when you first started school.

2. You don’t have to wait to begin repaying your loans.

Usually you don’t have to make payments while in school — or during the six-month grace period after leaving school. But you can if you want — and it will likely save you money since you’ll reduce your balance.

3. Taking longer to pay off your loans will cost you more money.

Interest accrues over time, and the more time you spend paying off your loans, the more interest your loan will cost. Paying off a larger portion of your loan — for instance, more than your minimum payment — per month helps shrink the principal faster, thereby decreasing total interest costs.

For a closer look, check out the free 10-minute online interactive video, “Understanding How Interest Works,” from Navient and EverFi.

Nikki Lavoie is a spokeswoman at Navient, a student loan servicer helping more than 12 million customers successfully repay their student loans.

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