Student loans can feel like an endless money pit, especially if the majority of what you’re paying each month is going toward interest instead of to your principal. If you’ve ever wondered why your student loan balance barely moves even when you’ve been making payments for a few months, don’t worry -you’re not alone. Once you understand how student loan interest works, you’ll be better able to make financial decisions and get rid of your loans sooner.
How does student loan interest work?
Student loan interest is calculated daily and added to your balance over time. The amount of interest you owe depends on:
- Your loan balance
- Your interest rate
- The number of days since your last payment
Federal student loans use simple interest, which means interest is based only on the principal balance, not on previously accrued interest. However, if you miss payments or let interest build up, capitalization can occur, adding unpaid interest to your principal and making your debt grow faster.
Read more: What happens to my student loans if I become permanently disabled?
Why do early payments go mostly to interest?
If you have noticed that most of your payment in the early years goes toward interest rather than principal, that is because of amortization. Student loans, like mortgages, follow an amortization schedule where:
- Early payments mostly cover interest, with little going to principal.
- Over time, as the principal decreases, less interest is charged, allowing more of your payment to reduce the loan balance.
This is why it can feel like your loan is barely shrinking, even though you are making payments every month.
Why does my interest and principal payment change each month?
Your loan balance, interest rate, and how often you make payments all impact the portion of your payment that goes to interest versus principal. Here is why your payments might vary:
- Payment timing: If you make a payment a few days earlier or later than usual, the interest amount will change because interest accrues daily.
- Extra payments: If you make an extra payment, more will go toward the principal, reducing the total interest you owe in the future.
- Accrued interest from school or deferment: If your loans were in deferment or forbearance, interest may have built up, and your first few payments will likely go toward paying off that interest before reducing the principal.
Read more: How can I get my 1098-T Form and 1098-E Form for my Student Loans?
How can I reduce the amount of interest I pay?
If you wish to pay your student loans fast and prevent accruing interest rates, here are a few tips you can try:
- Make additional payments: That tiny additional payment will reduce your principal faster and reduce your interest rate.
- Bi-weekly vs. monthly payments: Paying half a month’s payment each month for every other week works out to an extra payment yearly, saving on interest fees down the road.
- Make automatic payments: Some loan servicers offer interest rate discounts if you enroll in automatic payments.
- Refinance loans: If you can qualify for a lower interest rate by refinancing, you will save interest over the life of your loan.
- Defer or forbear only as a last resort (avoid this if you can): Interest continues to accumulate during these periods, so you will pay more overall.
Student loans can be infuriating if interest makes them feel like a never-ending battle. But you can take control of your loan payment by understanding how interest accumulates and how to minimize its effect.
Continue reading:
What are the pros and cons of consolidating my student loans?
What happens if I make extra payments on my student loans?
Will I still get student loans or are they affected by Trump’s federal funding freeze?
