Student Loan Interest: How Does it Work When I’m in School?

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Updated on Thursday, May 26, 2016

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We all know that student loans accrue interest, but exactly how and when interest begins accruing on various types of student loans can be a confusing topic. For example, some types of loans begin accruing interest while you are still in school, while others do not. Additionally, some loans accrue interest during the grace period (the period between when you graduate, withdraw from school, or drop below half-time status, and when your first loan payment is due), while others don’t start accruing interest until after the grace period is over.

It’s important to make sure you understand when interest will begin accruing on each of your student loans, since the amount of interest that accrues can substantially impact the amount of money you ultimately have to pay back. The first step is to check whether your loans are federal or private, and, if they’re federal, what type they are (e.g. subsidized or unsubsidized). With subsidized loans, the government assists the borrower by paying the interest during certain periods.

When interest capitalization occurs

Capitalization is the process of your unpaid interest being added to the principal balance of your loan. Interest does keep accruing after the capitalization process occurs, but the first one is likely to happen after your grace period on student loans is up.

Here is a rundown of the different types of student loans, along with notes about when each one begins accruing interest. You can find additional information about federal student loan interest at the Federal Student Aid website.

Federal subsidized loans

These loans are available to students who have demonstrated financial need.

  • Does interest accrue while I am in school? No.
  • Is there a grace period? Yes, six months.
  • Does interest accrue during the grace period? If your subsidized loan was disbursed between July 1, 2012 and July 1, 2014, it will accrue interest during the grace period. If it was disbursed before or after this period, it will not accrue interest during the grace period. Keep in mind that this could change again for future loans though.

Federal unsubsidized loans

These loans are available to students regardless of whether financial need has been demonstrated.

  • Does interest accrue while I am in school? Yes.
  • Is there a grace period? Yes, six months.
  • Does interest accrue during the grace period? Yes.

Federal PLUS loans

These loans are disbursed to students and parents of students in cases where the cost of a higher education program is not covered by other loans or forms of financial aid.

  • Does interest accrue while I am in school? Yes.
  • Is there a grace period? Student borrowers have a grace period of six months. Parent borrowers are expected to make payments as soon as the loan is disbursed but may request that payment due dates be delayed until after the student has graduated or left school.
  • Does interest accrue during the grace period? Yes.

Federal Perkins loans

These loans are available to students with “exceptional financial need”.

  • Does interest accrue while I am in school? No.
  • Is there a grace period? Yes, nine months.
  • Does interest accrue during the grace period? No.

Private loans

These are loans through banks or other private lenders rather than through the federal government, which means that the terms of the loan may vary depending on your specific lender. It’s important to check with your lender to get accurate information about the details of interest accrual and repayment requirements. Many private lenders may not offer a grace period, and interest will likely begin accruing while you are in school, but check with your lender to be sure.

What you should do to minimize accruing interest while in school

Minimizing the amount of interest that will capitalize is an effective way to reduce the total amount you’ll pay back over the life of the loan. The interest keeps on accumulating after the initial capitalization (principal + unpaid interest), so the lower the amount added to the principal balance, the less you’ll be charged in interest.

Here are a few ways to reduce the interest capitalization.

Work while in school

The action of working alone won’t do much, but it can give you money to pay off at least the interest accruing on your loans. You may even be able to save up enough to take out smaller loans the next year – or better yet – no loans at all. Be sure to explore all the work opportunities on campus, especially jobs that offer tuition assistance such as working as a resident advisor.

Make interest-only payments during school and/or the grace period 

Don’t wait until graduation and after the grace period to start making payments. You can use your money earned working during the school year, or the summers, to make interest-only payments. You can also make more significant payments towards the principal balance if you have the funds. Interest-only payments are a smart way to get ahead of your post-graduation student loan burden. These payments allow you to start paying off the interest as it accrues instead of waiting for it to capitalize on the principal debt.

If you have a subsidized loan, then you should definitely start making payments because you’ll be chipping away at the principal balance. 

Return excess loans

Did you take out more loans than you needed? You might be able to battle your student loan buyer’s remorse. You typically have 120 days after your loans have been disbursed to return the money to your lender; however, you should double-check the fine print as your school may have a shorter timeline to help you with the process.

It can be really tempting to cover your cost of living with student loans, but it’s a move that will cost you dearly in the future. Make an effort to only borrow what you truly need to pay for college instead of using funds to buy coffees between classes, go out to bars with friends and decorate your dorm room.

Pay more than the minimum due

The final strategy helps you attack your interest once those payments come due. Make an effort to pay as much above the minimum payment as possible and be sure to tell your lender you want the extra money applied to your principal balance. The faster you pay down the debt, the less interest you’ll pay overall.

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