Paying Off Interest vs. Principal on Student Loans (a Guide)

Written by: Kristyn Pilgrim
Updated: 2/26/20

Most loans, including student loans, will accrue interest over time. This added money means you will end up paying more than you borrowed.

You can defer interest payments on some types of loans while you are in school or starting your career. Then, you can begin making regular payments on both the principal and interest on your student loans. 

Student Loan Interest vs. Principal Payments

It is important to pay off both the interest and principal on student loans in your name. Each monthly payment you make after graduation should include that month’s accrued interest and some amount on the principal. But certain financial situations can make you wonder: Is it better to pay off the interest or the principal on your student loans? If you suffer financial hardship, should you focus on one over the other?

Loan servicers typically consider your standard monthly payment to apply to: 

  • Fees on the loan
  • Accrued monthly interest on your loan
  • Your loan’s principal amount

Each payment is calculated to include these fees unless you request otherwise. If you pay less than the standard payment, your lender will put that money toward interest but not the principal. When you pay more each month, that money can go toward your principal or your next monthly payment, but you must specify which you prefer. 

Student Loan Interest Accrues on the Principal Differently Depending on Your Loan

Ultimately, any payment plan you use on your loan should pay off the principal. The principal of your loan is the amount of money you borrowed to pay for your education. For example, if you borrow $10,000 for a year of school, the principal on your loan will be $10,000.

Depending on the type of loan you take out, you may have a fixed interest rate, which is set at the time you accept the loan and never changes, or a variable interest rate, which is based on stock market fluctuations.

There are four basic types of loans you can accept as a college student.

  • Federal direct subsidized loans: These loans are structured to help undergraduate students with significant financial need. Interest accrued on the loan while you are in college will be paid for by the Department of Education. You will receive a six-month grace period after graduation to let you search for a job.

    If you received a subsidized loan between 2012 and 2014, accrued interest during your six-month grace period will be added to your principal if you do not pay it in monthly installments.

    Subsidized loans have a fixed interest rate. You can adjust your payment plan in several ways after you graduate, based on your income.
  • Federal direct unsubsidized loans: Like subsidized loans, these loans have a fixed interest rate and a six-month grace period after you graduate. Unlike subsidized loans, the principal will begin accruing interest as soon as the loan has been disbursed. If you take out $5,000 to pay for a semester, that loan will begin accruing interest immediately.

    Most students request a deferment on loan payments while they are in school, so their unsubsidized loan’s interest will be capitalized and added to the principal on the loan. That means the principal on your loan will be higher than what you borrowed when you graduate, and more interest will accrue on the loan faster.
  • Direct PLUS Loans: Like unsubsidized loans, Direct PLUS Loans have a fixed interest rate, and interest begins accruing as soon as the loan has been disbursed.

    Unlike both subsidized and unsubsidized loans, there is no post-graduation grace period, so you must begin making monthly payments on this loan or ask for a deferment. As with an unsubsidized loan, if you defer your loan, the interest will be added to the principal, and you will end up paying much more than you borrowed.
  • Private loans: While private loans may have different terms in their contracts, they often work similarly to Direct PLUS Loans. Interest begins accruing after the loan is disbursed, and you will be expected to make monthly payments on at least the interest while you are in school, or you will need to ask for a deferment.

    When you defer your loans, the interest will continue to accrue, and this will be capitalized to your principal. If you defer regular student loan payments, you may be expected to pay interest each month, but not the principal.

Most student loans require interest payments on top of paying the principal, although they typically do not expect you to pay down the principal of the loan while you are in school. If you’re wondering whether it is better to pay off the interest or the principal on student loans while you are still in college, you should focus on making interest payments as often as possible.

Most students need loans to help them pay for tuition, associated fees, and living expenses while they are in school. Even if they can get a job, this work is likely to be part-time, so they can remain at least a half-time student.

If you are able to pay down the interest on your loans while you are in school, you will end up paying less on your loan over time. This helps you pay off the interest faster after you graduate.

How Can I Pay Down the Interest and Principal on My Student Loans?

Most students take out multiple student loans while they are in school, so you must decide which loans to focus on as you begin making larger monthly payments. You will also want to make sure your monthly payments pay down the principal on the loan. Since the total amount of interest is calculated based on the principal amount, you will ultimately pay less interest as you pay down the main part of the loan.

To help you pay down your loan faster, here are some recommendations: 

  • Start paying sooner than required. If you can make monthly interest payments while you are in school, do so. If you are financially able, pay some of the interest and principal during the six-month grace period, as well.

    Getting a head start and making consistent, extra payments means you will pay less interest and pay down your principal faster. Your interest payments will be tax-deductible once you start making them, so you can lower your tax burden.
  • Make bigger payments whenever possible. If you get a bonus, some extra cash from a second job, or a raise, start paying more on your student loans. Standard payments go toward fees, accrued interest, and principal, in that order. When you pay more, you can either advance the additional money to the next monthly payment, or you can request that the additional money goes toward paying down your principal.

    Again, paying more on the principal means you pay less interest, since that is a percentage calculated based on how much of the principal amount remains.

    WARNING: when you make extra payments, you MUST tell your loan servicer to apply this additional money to principal. It sounds crazy, but if you do not the servicer may assume these payments are “paid ahead” amounts for future payments. Contact your servicer to find out the proper way to apply payments to principal and then verify that they have actually done so.
  • Prioritize high-interest loans. If you have multiple loans and you do not need to consolidate or refinance them into one payment, focus on the highest-interest loan first. These will be the largest payments. If you can pay down the principal on this loan faster while making minimum payments on your other loans, you can use the debt avalanche payment method to pay down each loan.
  • Refinance or consolidate. If you have several student loans, and it is difficult for you to make multiple payments to different loan servicers, you can either consolidate or refinance the loans depending on the type of loans you have.

    If all your loans are federal student loans, you can use a direct consolidation loan to combine them. You will get a new fixed interest rate based on the weighted average of each loan being consolidated, and your repayment schedule will be updated. Direct consolidation loans allow you to pay over the course of 20 to 30 years rather than 10 years.

    If you have a private student loan or a combination of private and federal student loans, you can refinance these loans under one private lender. This process is like federal consolidation, except many private lenders allow you to choose a fixed or variable interest rate and a wider range of times to repay the loan. For example, you could choose to repay your new refinanced loan in five, seven, 10, 15, or 20 years.

Paying in fewer years means you pay more on your principal and less in overall interest. However, these plans do not work for everyone. Sometimes, paying over 20 years works better for a person’s budget. 

Paying Down the Principal on Your Student Loans Is Crucial

No matter which payment plan you choose for your student loans, you must start paying the principal down so you can repay the whole loan; making minimum payments on accrued interest will not get rid of your student loan debt.

While you can work with your loan servicer to ease your financial burden by temporarily making only monthly interest payments, you will benefit more in the long term by finding ways to pay down the principal faster.

Be sure to claim any student loan interest over $600 on your taxes so you can ease your tax burden. This will help you stay financially solvent so you can continue to pay down the principal on your loan.