How interest applies to loans and what it means for you.
In the grand scheme of debts, student loans are actually a little special when it comes to how interest gets applied. After all, since you take out the loans to focus on your education, it’s hardly fair for interest to accrue normally. Otherwise, by the time you graduate, your loans would be doubled in size before you ever start making payments…
So student loan has special considerations when it comes to interest, and understanding these differences can make or break your ability to pay off your loans effectively.
Fact: The Bipartisan Student Loan Certainty Act of 2013 tied student loan interest to the Treasury note index
How is interest assessed?
The first difference with student loan interest comes in how interest gets applied to your loans. For other types of debt, APR is set based on your credit score. But that doesn’t work for student loans, because often students don’t have any credit history to qualify for low APR.
So instead, the rates are set by the government (at least on federal loans, which represent the bulk of borrowing). Prior to August 2013, rates were set by Congress and a new vote had to happen every time. Legislative gridlock in 2013 led to APR jumping to 6.8% percent.
So the Bipartisan Student Loan Certainty Act of 2013 changed that system. Now interest on student loans is tied to the T-Note index and it gets set every year.
Fact: In 2014, Stafford Loan APR is set at 3.86% for undergrads and 5.41% for grads
If you have a $40,000 in student loan debt at 3.86% APR, how much interest will you pay over the life of a 10-year loan?
a) About $2,500
b) Around $4,100
c) Just over $7,700
d) More than $10,000
To be exact, you’ll pay $4,139.47 before the loan is paid off.
b) Around $4,100
How is interest deferred?
The next major difference is the fact that interest gets deferred (delayed from applying) until a certain time after you graduate or stop attending classes at least half the time. Essentially, your loans don’t grow with added interest until after you’re out of school.
Then once, you graduate or stop attending classes, interest gets applied and your first payments are due.
Is it possible for the government to pay my interest for me?
Sound like a silly question? It’s not.
In fact, if you seek deferment on the basis of financial hardship or unemployment and you prove your case, then it is possible that the government will agree to make the interest payments on your loans until the deferment is over.
Basically, if you’re unemployed or really underemployed then you can seek a special deferment that delays your payments and makes you eligible for this government assistance. You need to talk to a student loan help specialist to see if that’s an option you can use.
Can consolidation reduce my interest rate?
Maybe – and this is what confuses a lot of people (and where you see a lot of consolidation program providers stretch the truth a little).
When it comes to student loans, consolidation only reduces your interest rates in some cases. If you took out your loans under the old deal and your rates were really high, you may qualify for loan rates when you consolidate under this new deal… but that’s not always the case.
This differs from something like credit card debt consolidation, where one of the main goals is to get lower APR applied to your debts. The goal there is to reduce your interest rates to less than 10 percent or eliminate them completely in some cases.
But student debt consolidation is different. Here, the number one goal is to lower your payments. So if you see an interest rate reduction, that’s awesome. But if you don’t, that doesn’t mean you’re signing up for the wrong program – just that it may not be possible to get a better rate.
Only a specialist can tell you so you know for sure, so you need to talk to someone if you think you’re paying too much or your interest is too high.
If you’ve consolidated and are current with your payments, what’s the max amount of time you’ll be making payments?
a) Until the full balance is paid off
b) Until you default and get the debt discharged during bankruptcy
c) 25 years
d) Until you die
Your remaining balances are always erased after 25 years of payments, unless you qualify for a forgiveness program. On a forgiveness program, your remaining balances are forgiven after 10 years.
c) 25 years