Everything You Need to Know About Student Loan Interest Rates

When you borrow money from the Federal Government to pay for your education, you must pay back all of the borrowed money plus interest as a cost of borrowing that money.

Interest charges can cause you to pay back substantially more money on your student loans than you borrowed in the first place. It is important to understand how this interest can impact your overall debt and how you can keep that interest to a minimum.

Terms Used By the Government On Your Student Loan

Your Loan Disbursed Amountis the amount of money you initially borrowed. This number will not change for individual loans.

Your Loan Outstanding Principal Balanceis the amount of principal you owe at any given time during the life of your loan. This number will change based on what stage you are in your repayments and whenever specific events occur. This is also used to calculate your interest charges.

Interest charged on your Loan Outstanding Principal Balanceis called Loan Outstanding Interest Balance.

The total of your Loan Outstanding Principal Balanceplus your Loan Outstanding Interest Balanceis the total amount that you must pay back unless you get PSLF (Public Service Loan Forgiveness).

What Are Current Interest Rates?

The Federal Government determines interest rates on student loans every year. Current interest rates for loans disbursed between July 1, 2018, and June 30, 2019, are:

• Direct Undergraduate Loans – 5.05%
• Direct Graduate Loans – 6.60%
• Direct PLUS Graduate Loans – 7.60%

These rates are fixed and will not change over the life of the loan.

Your student loan interest is calculated as a percentage of the principal amount on a daily basis, which is different from mortgages and credit cards whose interest calculation is monthly.

Subsidized Loans Versus Unsubsidized Loans

Subsidized loans are no longer available on Direct Graduate loans. They are only available on Direct Undergraduate loans. For this reason, they are not significant for most doctors who generate the bulk of their debt during medical school.

Subsidized loans give students with financial needs a small break on their interest rates.

The day unsubsidized loans are disbursed, they begin accruing interest. In contrast, subsidized loans do not begin accruing interest changes as long as you are still a student (at least half-time), are in your grace period, or are in deferment. Note: This does not include forbearance. Note: Mandatory Medical Residency Forbearance is available while you are in residency, but it is a form of forbearance NOT deferment. Subsidized student loans in medical residency forbearance will accrue interest in residency.

How Your Loan Increases

All unsubsidized loans and eventually subsidized loans will increase from the original amount you borrowed. This growth can happen for a couple of reasons.

First, while you are not repaying your loans, interest is charged on the principal amount of the loan. This occurs during periods of deferral(while you are still in school), grace periods(right after graduation), and forbearance(you chose not to make payments).

Second, when you make payments on IDR (Income-Driven Repayment) plans that are smaller than the interest charged on your principal, your loan balance will grow. When your payments are less than the interest charged on your loan, it is called Reverse Amortization.

What is Interest Accrual? And How Can You Use It?

Unpaid student loan interest is not immediately added to your principal. If you understand this concept, you can use this knowledge to keep your interest charges – and ultimately your total payments – lower.

Unpaid interest is tracked separately and accruedin your account. This interest collects as your Loan Outstanding Interest Balance.

You are not charged interest on the Loan Outstanding Interest Balance. Your goal is to keep this interest from being converted to Loan Outstanding Principal Balance.

Example: You have a loan with a $135,000 outstanding principal balance, a $12,000 outstanding interest balance, at 6% interest. Your total debt is $147,000, but you are charged interest only on the $135,000. In this example, you are effectively getting a 5.51% interest rate.

Keeping accrued interest from being added to the outstanding principal balance is a good thing! Be careful, you can easily screw it up.

What is Interest Capitalization?

Interest capitalization is when the government gets to take the unpaid interest that has accrued on your loans and add it to the principal balance of your loan and start charging you interest on the entire amount.

Interest capitalization can occur at various times throughout the life of your loan. Some of these events you can control and some you cannot.

Interest capitalization events you CANNOT control include:

1. Following periods of deferment, forbearance, or grace periods. One of these will occur after you graduate.
2. If you are making income driven repayments using the PAYE or IBR plans and you no longer have a Partial Financial Hardship.

Interest capitalization events you CAN control include:

1. If you are making income driven payments using the RePAYE, PAYE, or IBR plans and voluntarily leave the plan for a different repayment plan.
2. You fail to annually re-certify your income for any of the IDR plans. Please remember to re-certify your income every year.

I see people switching from one IDR plan to another, trying to minimize the growth of their total debt while seeking PSLF, only to find that the change did them little good now that all of their accrued interest is being charged interest also.

Not all IDR plans have the same capitalization rules

PAYE has a cap on the amount of your unpaid interest that is added to your principal after a capitalization event. The cap is equal to 10% of your original loan balance. If your original loan balance was $150,000 and your accrued interest balance grew to $30,000, only $15,000 of the accrued interest will be added to the principal balance. The remaining $15,000 will stay as outstanding interest balance.

How are your payments applied to your debt?

In almost all cases, your payment is applied to your student loans in the following order:

1. Any fees on the account
2. Current interest since your last payment
3. Accrued interest
4. Principal balance

What About the Interest Benefit of RePAYE?

RePAYE has a benefit that can help tremendously in keeping your overall debt in control.

If your payment under the RePAYE plan doesn’t cover all of the interest that has accrued since your last payment, the government will forgive half of the unpaid interest. There is no limit on this benefit.

Example: You have a $150,000 loan balance at 6%. The interest charged since your last payment is $735. If your RePAYE payment is $245, that leaves $490 of unpaid interest. The government will forgive $245 of interest and add the other $245 interest to your outstanding interest balance.

Conclusion

Understanding how student loan interest works can save you money when paying off your student loans. Depending on your student loan goals, you may want to keep  some of the following tips in mind:

1. Are you planning on Public Service Loan Forgiveness (PSLF)? Use these ideas to keep your debt from ballooning out of control if something changes and PSLF is no longer an option for you.
   • Try to determine the plan that is best for you as soon as possible. Don’t switch Income-Driven Repayment plans more than necessary to keep accrued interest from capitalizing.
   • RePAYE has an excellent interest forgiveness benefit. If you don’t need the payment caps available from PAYE and IBR, RePAYE can be a great option.
2. Are you paying off your loans as quickly as possible?
   • Start making Income Driven Repayments as soon as possible in residency. RePAYE is a great option here. The forgiven interest might make your interest rate lower than any refinancing rate you can get.
   • Do not go into Forbearance during residency. The Income Driven Repayments will save you thousands of dollars later.
3. Are you planning for Long-term Taxable Forgiveness? Use these ideas to keep your debt from ballooning out of control and increasing your tax bill at the end of the repayment period.
   • Try to determine the plan that is best for you as soon as possible. Don’t switch Income-Driven Repayment plans more than necessary to keep accrued interest from capitalizing.
   • RePAYE has an excellent interest forgiveness benefit. If you don’t need the payment caps available from PAYE and IBR, RePAYE can be a great option.