When paying for college, many students take out a student loan, but when you go to repay your student loans, you'll have to pay student loan interest. Interest is the cost your lender charges you to borrow money. Each day, interest accrues on your loan, making your loan balance higher. When you make a payment, you'll need to pay off this interest before you reduce the balance by paying principal.
It's important you understand how interest works in order to calculate the total cost of borrowing. It's also important to understand your loan rate so you can manage your student loans effectively, make payments that reduce your student loan debt, and make a plan to become debt-free.
If you have private student loans and your interest rate is too high, you may want to look into refinancing your student loans. This could potentially reduce the student loan interest rate and total costs you pay. If you have a private student loan, use an online tool like Credible to compare student loan refinance rates from multiple lenders at once without affecting your credit score.
How to find out how much interest you pay on student loans
To understand exactly how much interest you're paying on student loans, follow these steps:
- Find out what your interest rate is: You can find this out by reviewing your loan paperwork, signing into your account or asking your lender. Be aware that if you have variable interest rates, your rate could change over time. You won't have this issue with a fixed-rate loan. If you want to reduce your rate by refinancing, an online student loan refinance calculator can give you a sense of what your new monthly payments could be and how much you could potentially save on your loan payment.
- Determine your daily interest rate: That's the amount of interest you're charged each day you owe money. You can take your annual interest rate and divide it by 365 to calculate your daily student loan rate. For example, if your interest rate is 5%, you'd divide 0.05 by 365 to see that your daily rate is 0.00013699.
- Find out how much your principal balance is: That's the outstanding loan amount you owe. If you borrowed $10,000 and haven't made a single payment or accrued any interest, your principal balance would be $10,000.
- Multiply your outstanding balance by your daily rate: If you owe exactly $10,000 and your daily rate is 0.00013699, you'd accrue around $1.37 in interest every day
- Calculate the interest you owe each billing cycle: Most billing cycles last for 30 days. If yours does and you pay $1.37 in interest daily, you'd pay around $41.10 in interest each month.
Some private loan lenders compound interest daily, so they add daily interest onto the principal balance as it accrues. Then, you're charged interest on that higher amount. If interest compounds daily under the terms of your loan, you wouldn't owe $10,000 on the second day -- you'd owe $10,001.37. Interest the next day would be calculated on a balance of $10,001.37 instead of $10,000, and so on each day.
If you're unhappy with the amount of daily interest you're paying, consider refinancing. This is generally not a good idea with federal student loans because you'd have to give up borrower benefits such as protection if you lose your job, any future student loan forgiveness or the loan forbearance in place during COVID-19 that allows borrowers to put their federal student loan payment on hold. But it can be an effective way to reduce borrowing costs if you have private loans and qualify to refinance at a lower rate than your lender is currently charging.
You can use an online tool like Credible to view a rates table that compares rates from multiple private lenders at once to help you decide if refinancing makes sense.
How much you're paying toward your principal balance
Once you know how much your loan interest rate is each month, you can calculate how much each payment you make reduces your principal balance.
Say that your monthly payments on your loan are around $106 per month (based on borrowing $10,000 at 5% and paying it off over 10 years). If you're accruing $41.10 in interest each month, the first $41.10 of your monthly payment will go to pay off that accumulated interest. You'd reduce your principal balance by $64.90 for each monthly student loan payment you make.
If you qualify for the best student loan refinance rates and you refinance, your new lower rate could mean less interest accrues each month so more of your payment goes to principal. Use an online tool like Credible to get prequalified student loan refinance rates without affecting your credit score.
Have a finance-related question, but don't know who to ask? Email The Credible Money Expert at email@example.com and your question might be answered by Credible in our Money Expert column.