The use of private and federal student loans to finance a college education is a common financing strategy, but students often do not know how interest on these loans arises during deferment and repayment. Although all student loans accrue interest on a daily basis while being repaid, it depends on the type of student loan when that interest starts to grow. Subsidized student loans, or loans that are compensated by the federal government because of a low income earned, only start to accrue interest after the grace period of six months starting after leaving school or graduates. Non-subsidized loans, however, start to generate interest from the day they are paid to the school or student, even if the repayment has not yet begun.
The daily accrual percentage of the interest on student loans can be calculated by multiplying the interest rate by the current principal sum and then dividing this amount by the number of days in the year. For example, a student loan with a principal balance of $ 10,000 and an interest rate of 6% accrues daily interest costs of $ 1.64. Most student lenders apply each monthly repayment in the following order: interest accrued since the last payment date, late payment terms if applicable, then the current balance of the principal. In the first years of repayment, the amount of the monthly interest payment is greater than the amount applied to the principal.
Students who do not pay the interest that comes from their non-subsidized loans while they are deferred, have capitalized interest as soon as the repayment starts. This means that all accrued interest is pinned to the principal amount of the student loan, and interest accrues from that new balance as soon as the repayment starts. Ultimately, students can pay much more in total repayment during the term of their student loans if accrued interest is not paid before the full repayment is completed.