Interest rates on loans come in different versions and sizes. It is important to consider all aspects of loan interest as you are accepting loan terms and signing promissory notes.
There are also fees associated with taking out loans prior to interest accumulation.
Federal Direct Loans1 are student loans with their interest rate set by federal law and regulations.
Student loans come in both subsidized and unsubsidized versions. Subsidized means that the government is subsidizing (paying) the interest while the student is enrolled and often when in a grace period2. They are not interest-free loans but are not accumulating interest during defined periods.
Unsubsidized loans are collecting interest from the point of disbursement. Interest-only payments can be made to reduce compounding, the process of accumulated interest onto the principal of the loan and paying interest-on-interest later.
The interest rate for your loan is determined by the time when it was disbursed -- not when it is in repayment. Therefore, the loan you take out for one academic year may have a different interest rate from the loan you take out the following year.
The long-awaited Bipartisan Student Loan Certainty Act of 2013, passed July 31st and signed into law August 9th, resulted in new legislation that changed student loan interest rates retroactive to July 1, 2013. Under the new law, interest rates that were scheduled to double to a fixed 6.8% were changed to a new rate standard.
Now loan interest rates will be based on the 10-year Treasury bill each June 1 plus an added percentage – an added 2.05% for undergraduate Federal Direct Subsidized and Unsubsidized Loans and an added 3.6% for graduate Federal Direct Unsubsidized Loans. When the economy is strong and government borrowing is more costly, the higher interest is passed onto the student loan borrower as well. Likewise, savings during more sluggish periods also result in lower interest rates for borrowers.
Undergraduate Direct Sub and Unsub Loan rates for loans first disbursed July 1, 2013, through June 30, 2014, will therefore be 3.86%, and graduate and professional students will have a 5.41% rate on the Direct Unsub4 Loan.
Loans would be “variable-fixed,” meaning students would receive a new rate with each new loan, but then that rate would be fixed for the life of the loan. The law included caps of 8.25% for undergraduate and 9.5% for graduate Federal Direct Sub and Unbsub Loans to prevent loans from exceeding those rates.
Many students also have loans first disbursed beginning July 1, 2006. Rates are as follows for these loans:
All student loans taken between July 1998 and June 2006 had a variable interest rate reset each July 1 that cannot exceed 8.25%.
Speak with your lender to know the current interest rate on variable rate loans taken out prior to July 2006.
Federal PLUS Loans taken by graduate students or parents of undergraduate, dependent students are more straight forward in their interest accumulation. Like unsubsidized loans, interest begins when the loan is disbursed. Borrowers can elect to make loan payments at that point, interest-only payments, or can request the loan be deferred during the student's enrollment. Note that if full deferment is done, the interest will accumulate and compound onto (be added to) the loan principal.
As noted above with Direct student loans, the rates for Federal Graduate and Parent PLUS Loans also changed to a rate based on the 10-year Treasury bill plus an added percentage – an added 4.6% in this case.
PLUS Loan rates for new loans first disbursed July 1, 2013, through June 30, 2014, will be 6.41%.
PLUS Loans will also be “variable-fixed,” where the borrower receives a specific rate with each new loan, but that rate is fixed for the life of the loan. The cap of 10.5% sets the maximum interest rate PLUS Loans could reach.
Beginning July 1, 2010, UC processed PLUS Loans through Direct Lending (DL). PLUS Loans secured from July 2006 through June 2013 in DL had a fixed 7.9% interest rate.
Interest rates on PLUS Loans previously borrowed at UC and first disbursed beginning July 2006 were fixed at 8.5% if the loan is borrowed in the Federal Family Educational Loan (FFEL) program that used a lender.
PLUS Loans (both FFEL and DL) first disbursed July 1998 through June 2006 have a variable rate that reset each July 1 capped at 9.0%. Speak with your lender to know the interest rate on variable rate loans borrowed during this period.
Interest is calculated and accumulates on loans annually (once each year) for federal loans.
Note that non-federal educational loans may have interest calculated and added to the loan quarterly (four times a year). The frequency of this determination can greatly increase the cost of a loan. Obviously, the more often interest is calculated and added to the loan, the more the borrower is paying back in interest-on-interest.
It is advisable, when considering non-federal loans, that families compare the loan to the Federal PLUS Loan option.
Borrowers should also review the length of the loan. Federal loans offer a standard 10-year repayment. Online loan information can give you an idea of your monthly repayment amounts. Other options can also be exercised when you go into repayment.
Always recognize that the longer the loan repayment, the more you will repay in interest. While a longer loan can present lower monthly repayments, it can also result in a much higher amount to be repaid.
On the flip side, you can reduce your loan costs whenever you have a personal budget surplus. Think about increasing your payment beyond the minimum monthly amount whenever you can. But if you do, contact to servicer to ask to have any excess payment applied to accumulated interest first. This will reduce additional interest being charged on already accumulated interest.
Next, federal loans typically do not have any penalties for early repayment. If you can add to your monthly payment or make multiple payments when you get more financially on your feet, you can pay off the loan in a shorter period of time and reduce interest accumulation.
Don't judge a loan simply by the interest rate numbers. Look into the frequency of interest calculation and the length of the loan to better know the full repayment cost of borrowing for your education.
Three key points that can assist you in managing your loans and comparing federal and non-federal loan programs: