Does Interest Accrue While in School?
Learn how student loan interest accrues while you're in school and what steps to take before repayment begins.
Student loans help many individuals cover higher education costs like tuition, housing, and books. Understanding how interest functions is a core part of managing this debt. Interest is the cost of borrowing money, calculated as a percentage of the outstanding loan balance. This charge accrues over time, increasing the total amount borrowers must repay beyond the original principal.
Student Loan Interest Accrual
Interest accrual is the process where the amount owed on a loan steadily increases due to the continuous calculation of interest on the principal balance. For student loans, the timing of this accrual depends on the loan type. Federal student loans fall into distinct categories with different interest accrual rules while a student is still in school.
Federal Direct Subsidized Loans are for undergraduate students with financial need. The U.S. Department of Education pays the interest that accrues while the student is enrolled at least half-time, during the grace period, or during authorized deferment periods. This means interest does not accumulate on these loans, and the loan balance does not grow while a student is in school.
In contrast, Federal Direct Unsubsidized Loans are available to both undergraduate and graduate students, regardless of financial need. Interest begins accruing immediately after the loan funds are disbursed, even while the student is in school. The borrower is responsible for all accrued interest from disbursement until repayment. Although payments are not required while enrolled, the loan balance can increase significantly due to this accumulating interest.
Private student loans, offered by banks and other private lenders, function similarly to unsubsidized federal loans regarding interest accrual. Interest on most private loans begins to accrue as soon as funds are disbursed. The specific terms and conditions, including when interest starts and how it is calculated, can vary widely among different private lenders, so reviewing individual loan agreements is essential.
Managing Interest While Enrolled
When interest accrues on student loans while a borrower is enrolled, such as with unsubsidized federal and most private loans, proactive steps can be taken. Making interest-only payments during enrollment can be a beneficial strategy. This approach helps reduce the total interest paid over the loan’s life and prevents the loan balance from growing larger. Even small, consistent payments towards the accruing interest can make a difference in the long run.
A primary reason to manage accruing interest is to avoid capitalization. Capitalization occurs when unpaid, accrued interest is added to the loan’s principal balance. This process increases the total amount owed, and future interest is calculated on this new, higher principal amount, leading to a greater overall cost for the borrower. For instance, if $500 in interest capitalizes on a $10,000 loan, the new principal becomes $10,500, and future interest will be calculated on that larger sum.
Capitalization typically happens when a period of authorized non-payment ends, such as the grace period, or following periods of deferment or forbearance for unsubsidized loans. By making interest payments while in school, borrowers can reduce or eliminate the amount of interest that capitalizes. This proactive measure ensures interest is not charged on previously accrued interest, lowering the total repayment amount and potentially reducing future monthly payments. Borrowers can contact their loan servicer to determine the monthly interest amount and set up payments to cover it.
Grace Periods and Repayment
After a student graduates, leaves school, or drops below half-time enrollment, most student loans enter a grace period. This is a temporary interval during which borrowers are not required to make loan payments. For the majority of federal student loans, including Direct Subsidized and Direct Unsubsidized Loans, this grace period typically lasts for six months.
During the grace period, interest accrual depends on the loan type. For Federal Direct Subsidized Loans, interest generally does not accrue, as the government continues to pay this interest. This means the principal balance for these loans remains unchanged during this period.
However, for Federal Direct Unsubsidized Loans and most private student loans, interest continues to accrue during the grace period. While payments are not mandatory, any unpaid interest that accumulates will typically capitalize once the grace period ends and formal repayment begins. This capitalization increases the overall loan amount, leading to higher monthly payments and a greater total cost over time. Making interest-only payments during the grace period for unsubsidized and private loans can help prevent this increase in the principal balance.