Is Federal Student Loan Interest Monthly or Yearly?

Federal student loan interest accrues daily, not yearly or strictly monthly. The annual interest rate determines the total interest charged over a year, but this amount accumulates daily based on the outstanding principal balance. This daily accrual means that interest continuously builds, even when payments are not required. Accrued interest is then typically added to the loan balance monthly, affecting the subsequent calculation of interest. Understanding this daily accrual and monthly application is important for effective loan management.

Understanding How Interest Accrues

Federal student loans utilize a simple daily interest formula, meaning interest accumulates every day on the unpaid principal balance. Daily interest is calculated by dividing the annual interest rate by 365.25 (to account for leap years) and multiplying it by the current principal balance. This calculation provides the amount of interest that accrues each day. For example, a $10,000 loan with a 5% annual interest rate accrues approximately $1.37 per day ($10,000 0.05 / 365.25).

While interest accrues daily, it is typically added to the loan balance monthly, aligning with billing cycles. Payments are generally applied first to outstanding interest, then to the principal balance. If payments do not cover accrued interest, unpaid interest can be capitalized, increasing the principal balance on which future interest is calculated.

Factors Influencing Your Interest Rate

Federal student loan interest rates are fixed for the entire life of the loan once it is disbursed. These rates are not determined by individual credit scores but are set by federal law through Congress each year.

The interest rate depends on the specific type of federal loan and the academic year in which it was first disbursed. Rates are announced annually for loans disbursed between July 1st and June 30th of the following year. For instance, Direct Subsidized, Direct Unsubsidized, and Direct PLUS loans each have their own distinct rates, which are tied to the yield of the 10-year U.S. Treasury note.

When Interest Begins to Accrue

The timing of when interest begins to accrue on federal student loans depends significantly on the loan type and the borrower’s enrollment status. For Direct Subsidized Loans, the government pays the interest while the student is enrolled at least half-time, during the six-month grace period after leaving school, and during periods of deferment. Thus, for these loans, interest generally does not accrue to the borrower until repayment begins.

In contrast, interest on Direct Unsubsidized Loans and Direct PLUS Loans begins accruing from the date of the first disbursement. This applies regardless of whether the student is still in school, in a grace period, or in deferment. Although interest accumulates from disbursement, payments are not required while in school or during grace periods; however, paying interest during these times can prevent capitalization.

How Interest Capitalization Works

Interest capitalization occurs when unpaid accrued interest is added to the principal balance of a federal student loan. This increases the total amount owed, and future interest then accrues on this new, higher principal balance. This can increase the total loan cost and potentially lead to higher monthly payments.

Capitalization takes place at the end of a grace period for unsubsidized loans, or when a loan exits deferment or forbearance. For example, if an unsubsidized loan borrower does not pay interest accrued while in school or during a grace period, that interest will be capitalized when repayment begins. Similarly, interest accrued during deferment or forbearance may be capitalized when those periods end, especially for unsubsidized and PLUS loans.