When it comes time to repay your student loans, part of your monthly payment will go to your principal balance, or the amount you took out to pay for school. Another part will go toward your interest, or what you pay the lender for giving you a loan. You could have simple or compound interest, depending on which type of student loan you took out.

Simple vs. Compound Interest

Simple Interest

澳洲幸运5官方开奖结果体彩网:Simple interest is calculated based on a loan’s principal balance and doesn’t compound. The United States Department of Education uses the following simple daily interest formula to calculate interest charges on a federal student loan:

Outstanding Principal Balance * Interest Rate Factor * Number of🌊 Days Since Last Payment

Simple daily interest is similar to simple interest, with the major difference being that the interest charged is based on the actual principal balance each day.

Let’s say you borrowed $20,000 at a 5% simple interest rate with the standard 10-year repayment plan. To determine the 澳洲幸运5官方开奖结果体彩网:interest rate 𝔉factor, divide the interest rate by the number of daysꦑ in a year, which gives us 0.0136% (0.05 / 365 = 0.000136). 

Next, in order to determine how much interest is charged each day, multiply the interest rate factor by the original😼 loan principal. This gives us a daily♌ interest charge of $2.72 ($20,000 * 0.000136).

Finally, multiply the interest rate factor by the number🉐 of days in the monthly billing cycle (we’ll assume it’s 30 days), which gives us $81.60 ($2.72 * 30).♛ This is the amount of interest you’d pay for the month.

Compound Interest

澳洲幸运5官方开奖结果体彩网:Compound interest accrues on both a loan’s initial principal balance as well as the interest accumulated from previous payment periods. Interest can compound annually, monthly, daily, etc., and the number of compounding periods will determine how much compound interest will be charged.

Here’s how compound interest is calculated on the same $20,000 loan from earlier. For this example, we’ll assu🔯me interest is compounded daily.

On the first day of the loan, the daily interest charge is c🦩alculated by ꦯmultiplying the principal balance by the interest rate factor, which gives us $2.72 ($20,000 * 0.000136).

Your outstanding balance on the first day then becomes $20,002.72. On the second 🐽day, you’ll multiply the new principal balance by the same interest rate factor, which gives us approximately $2.7204 ($20,002.72 * 0.000136).

On the third day, your new balance will be $20,005.44. By the time your first monthly payment is due, the loan will have accrued $🧔83.50 in interest. 

Interest Capitalization on Student Loans

Interest capitalization refers to unpaid interest being added to a loan’s principal balance. Because capitalized interest becomes part of the principal, future interest will be charged on the new, larger amount.

Capitalization can occur under the following circumstances, depending on the type of loan:

• During deferment: If you decide to defer your direct 澳洲幸运5官方开奖结果体彩网:unsubsidized student loans, you can temporarily suspend payments without facing any penalties. But the interest will continue to accrue, and when the 澳洲幸运5官方开奖结果体彩网:deferment period ends, it will capitalize.
• While in forbearance: Although you’re not required to make monthly payments while your student loans are in 澳洲幸运5官方开奖结果体彩网:forbearance, interest will continue to be added to your outstanding balance. As with deferment, once the forbearance period is over, the accrued interest will capitalize.
• Within the grace period: If you have unsubsidized loans, you’re not required to make payments for six months after you graduate, but interest continues to accrue and will capitalize after the 澳洲幸运5官方开奖结果体彩网:grace period ends.

You might also face capitalization under an 澳洲幸运5官方开奖结果体彩网:income-driven repayment (IDR) plan. If your monthly payments are less than the amount of interest that accrues each month, the difference will be added to the principal balance.

The Bottom Line

The U.S. Department of Education uses simple daily interest to calculate how much inte🐷rest 😼accrues each day on a student loan, while private lenders use whichever type of interest they prefer. If your ๊lender prefers compound interest, then you’ll likely end up paying more in interest over the life of your loan than you w𓆏ould with a simple interest rate.