Do Unsubsidized Loans Accrue Interest?
Understand how interest accrues on unsubsidized student loans from day one and its impact on your total debt.
Student loans are a common way to finance higher education, and understanding their mechanics, especially how interest works, is important for effective financial planning. Unsubsidized loans differ significantly from their subsidized counterparts in how interest accumulates over time.
Understanding Unsubsidized Loans
Unsubsidized loans are federal student loans available to both undergraduate and graduate students. Unlike subsidized loans, eligibility is not based on financial need, making them accessible to a broader range of students. The total amount a student can borrow each academic year depends on their grade level and dependency status, with annual and aggregate (lifetime) borrowing limits also applying.
The borrower is responsible for all interest that accrues on the loan. This differs from subsidized loans, where the U.S. Department of Education pays the interest during certain periods, such as when the student is enrolled in school at least half-time, during a grace period after leaving school, or during periods of deferment. This responsibility for all accrued interest is an important distinction that impacts the total cost of the loan.
How Interest Accumulates
Interest on unsubsidized loans begins accruing immediately from the date the loan funds are disbursed to the school. The accrual of interest continues throughout all periods of the loan’s life, including during the in-school period, any grace period after leaving school or dropping below half-time enrollment, and during periods of deferment or forbearance.
Federal student loan interest accrues daily as simple interest on the principal balance. This continuous accrual means that if interest payments are not made, the total amount owed can increase even before repayment officially begins.
The Impact of Accrued Interest
The primary consequence of interest accruing on unsubsidized loans, especially if not paid, is interest capitalization. Capitalization is the process where unpaid accrued interest is added to the loan’s principal balance. This increases the total amount owed, because future interest will then be calculated on this new, higher principal balance.
Capitalization occurs at specific points in the loan’s lifecycle. For federal unsubsidized loans, this happens when the grace period ends, at the end of a deferment period, or after a period of forbearance. For example, if a borrower has $5,000 in accrued interest when their grace period ends, that $5,000 is added to their original principal, and interest is charged on the new, larger sum. Making interest payments while in school, during the grace period, or during periods of deferment or forbearance can prevent capitalization, reducing the total cost of the loan over time.