Updated on July, 26/2023
Disclaimer: This post contains a referral link to Splash Financial. If you use my referral link and decide to refinance with Splash Financial, I may earn a commission at no additional cost to you. For more information on the Refer a Friend Program see their Terms and Conditions.
Understanding Student Loan Interest
Do you feel like you are constantly making payments on your student loans but your balance has hardly budged? You have student loan interest to thank for that.
If your balance is barely going down…or worse, going up then I can assure you that you are not alone. 43.5 million people have student loan debt. The average debt those borrowers have is $37,787, according to an article on Credit.com.
Unfortunately, many borrowers are not seeing their balances go down very quickly no matter how many payments they make. It can feel confusing and deflating when the balance is not going down. The key to making progress on your student loans is to understand how payments are applied and how student loan interest works so you can make an effective plan to pay it off.
Don’t worry, no matter what your loan interest rate is, there is a way you can make progress on paying off your student loans!
How Payment is Applied
Each time you make a payment, the payment goes towards interest owed first, then any fees and then finally your principal. A good chunk of your monthly payments are going towards interest, which is why it feels like the the principal balance is not falling as quickly as you would like. And if you have an Income-Driven Repayment Plan, there is a good chance that ALL of your payment is going towards interest and nothing is applied to the balance.
This is why it’s important to make extra payments so you can knock down that balance faster. To do this though, double check your loan terms to make sure extra payments will go directly towards the principal and not treated as a normal monthly payment that goes towards interest as well.
Student Loan Interest Rate Calculation
There are 2 formulas that will help you understand student loan interest. Student Loan interest accrues daily and is calculated using a Daily Interest Formula and the Interest Rate Factor.
Interest Rate Factor = Loan’s Interest Rate / Number of Days in a Year
Daily Interest Formula = (Outstanding Principal Balance x Interest Rate Factor) x Number of Days Since Last Payment
For example, let’s say you have an Outstanding Principal Balance of $30,000 with 4% Interest Rate and it has been 30 days since your last payment.
Interest Rate Factor = 0.04 (interest rate) / 365 (number of days in a year)
Interest Rate Factor = 0.00010959
Daily Interest Formula = $30,000 (Outstanding Principal Balance) x 0.00010959 (Interest Rate Factor) x 30 (Number of Days Since Last Payment)
Daily Interest Formula = $98.63
$98.63 of your monthly payment will go towards interest.
That can be really frustrating if you are only making a $200 payment each month. Almost half is going towards interest!
*Interest on Federal student loans is currently set at 0% for all borrowers until September 1, 2023, when interest will start to accrue again. Read on Biden's New Student Loan Forgiveness Plan
Should You Refinance for a Lower Interest Rate?
The higher your student loan interest rate is the more money you are putting towards interest instead of principle. Refinancing to get a lower interest rate may help you here. As of July 26, 2023, Splash Financial is advertising fixed rates as low as 4.69% APR. If you are considering refinancing then check out my post, The Do’s and Don’t For Refinancing Private Student Loans and read though all the information at Splash Financial.
(Splash Financial is a referral link. You can check your rates for free and I may earn a small commission. If you decide to go ahead and refinance, I could receive $200 for the referral and you could receive $200 as well!)
Getting Ahead of Student Loan Interest
Now that you understand how payments and interest work, it’s time to make those things work for you. Making extra payments on your student loans is the best way to pay them off early and save thousands of dollars on interest. That is where the debt snowball comes in!
With the debt snowball, you will list all your loans from smallest balance to largest balance, regardless of interest rate. You will make the minimum payments on your loans and make extra payments on the smallest loan first. Once that loan is paid off, you tackle the next loan. Continue the process until you have paid them all off! This is exactly how I paid off my loans 5 years early and saved thousands of dollars on interest payments
Related Articles on Student Loans
Student Loan Repayment Plans That Are Costing You Money
The Do’s and Don’ts for Refinancing Private Student Loans
The Truths About Public Student Loan Forgiveness (PSLF)
Get Ahead of the Student Loan Interest Game!
