Published in Borrow
Written by Kristyn Pilgrim

Here’s How Student Loans Accrue Interest

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    Here’s How Student Loans Accrue Interest

    Published in Borrow
    Written by Kristyn Pilgrim

    Interest is essentially a fee paid by the borrower of a loan to a lender. The interest you pay on your student loan can either be a fixed or variable rate. As time goes on, interest accumulates – or accrues – between your monthly payments. The amount of accrued interest is a percentage of the unpaid principal (the amount borrowed).

    To understand how loans accrue interest, here are key terms:

    • Interest: Cost paid by a borrower to a lender for the use of borrowed money, calculated as a percentage of the unpaid principal
    • Loan: Money borrowed that must be paid back with interest
    • Lender: Provides the loan 
    • Principal: The amount of money lent; this is what interest is paid on

    Calculating Interest

    To calculate the interest that accrues on your loan between monthly payments, you can multiply your outstanding principal balance by the interest rate factor, and then multiply that number by the number of days since your last payment.

    The interest rate factor is used to calculate the amount of interest accrued on a loan. To calculate the interest rate factor, divide your loan’s interest rate by the number of days in the year.

    Fixed and Variable Interest Rates

    There are two types of interest rates that impact the overall amount you will pay over the life of your loan: fixed and variable.

    Fixed-rate loans have the same interest rate for the life of the loan. Examples of fixed-rate loans are federal student loans: Direct Subsidized Loans, Direct Unsubsidized Loans, and Direct PLUS loans. The majority (80%) of student loans are from the U.S. Department of Education. 

    The 2019-2020 fixed interest rate for Direct Subsidized Loans and Direct Unsubsidized Loans for undergraduate students is 4.53%; the Direct Unsubsidized Loan rate for graduate or professional students is 6.08%; and the fixed interest rate for Direct PLUS loans for parents and graduate or professional students is 7.08%.

    Variable interest rate loans are loans where the interest rate can increase or decrease during the life of the loan. Private loans can have either a fixed or variable interest rate. Variable-rate loans are tied to the loan’s stock market index; as the market changes, the rate changes, altering the overall payment the student is responsible for. 

    Direct Subsidized and Direct Unsubsidized Loans

    Federal Direct Subsidized and Direct Unsubsidized Loans differ in their terms and how interest is calculated for them. 

    Direct Subsidized Loans are available to undergraduate students based on financial need, with the amount you can borrow determined by your school. When you are at least a half-time student, for the first six months after graduation, and during a period of deferment (when your loan payments are postponed), the U.S. Department of Education pays the interest on the loan. 

    For Direct Unsubsidized Loans, there is no requirement of financial need. Like with subsidized loans, your school determines how much you can borrow; however, unlike subsidized loans, you are responsible for paying the interest on the loan during all pay periods. You have the option not to pay interest while you’re in school, during deferment or forbearance periods, and during grace periods (usually the first six months after you leave school); however, your interest will accrue and be capitalized (added to the principal amount of the loan). 

    For federal student loans disbursed on or after July 1, 2019, and before July 1, 2020, the fixed interest rate for undergraduate direct subsidized and unsubsidized student loans is 4.53%. Graduate or professional direct unsubsidized loans have a 6.08% fixed interest rate; and parents  and graduate, or professional students Direct PLUS Loans have a 7.08% fixed interest rate. 

    Interest Is calculated by multiplying your principal balance by the interest rate factor (the amount of interest accruing on your loan, calculated by dividing the interest rate by the number of days in a year), and then multiplying that by the number of days since your last payment.

    With income-based repayment plans, each year, you need to update your income by a certain deadline. If you do not make this update, any unpaid interest is added to the principal balance of your loan(s), increasing the total cost of your loan because you’re going to be paying interest on the principal plus the interest that was capitalized. Additionally, because income-driven plans extend your repayment period by creating lower payments, you’re likely to pay more interest over the duration of the loan before it is forgiven.

    Types of Federal Repayment Plans

    The U.S. government offers a loan simulator to help you determine which of the eight federal loan repayment plans you are eligible for and your monthly and overall payments. Private lenders offer their own repayment plans to choose from.

    Direct Loans and Federal Family Education Loan Program Loans

    Direct Loans and Federal Family Education Loan (FFEL) Program Loans offer quite a few repayment plans

    The Standard Repayment Plan has fixed payments to ensure a loan is paid off within 10 years. Direct Subsidized and Unsubsidized Loans, Subsidized and Unsubsidized Federal Stafford Loans, PLUS loans, and all Consolidation Loans are eligible for this plan, where borrowers will pay less over time than those who repay their loans with other plans.

    The Graduated Repayment Plan has lower payments at first, with payments typically increasing every two years, allowing you to pay off your loans within 10 years. However, it will cost more than the Standard Plan over time. Direct Subsidized and Unsubsidized Loans, Subsidized and Unsubsidized Federal Stafford Loans, PLUS loans, and all Consolidation Loans are eligible for this plan.

    The Extended Repayment Plan can be fixed or graduated and ensures loans are paid off within 25 years. Direct Subsidized and Unsubsidized Loans, Subsidized and Unsubsidized Federal Stafford Loans, PLUS loans, and all Consolidation Loans are eligible for this plan; however, you will pay more over time than under the Standard Plan. Monthly payments will be less than under the 10-year Standard or Graduated Repayment plans, but FFEL and Direct Loan borrowers must have more than $30,000 in outstanding loans to be eligible.

    Revised Pay As You Earn (PAYE) Repayment Plan monthly payments are 10% of your discretionary income (the difference between your annual income and a percentage of the poverty line for your family size and state you live in). Direct Subsidized and Unsubsidized Loans, Direct PLUS loans made to students, and Direct Consolidation Loans (not including PLUS loans – Direct or FFEL) made to parents are eligible. Payments are recalculated yearly, and if married, both partners’ income and debt will be considered. If you haven’t repaid your loan in full after 20 or 25 years, any outstanding balance will be forgiven. You’ll pay more over time with this plan than the 10-year Standard Repayment Plan, and you might have to pay income tax on any forgiven amount.

    The Pay As You Earn (PAYE) Repayment Plan is for new borrowers on or after Oct. 1, 2007, who received a disbursement of a Direct Loan on or after Oct. 1, 2011, with high debt relative to your income. Those with Direct Subsidized and Unsubsidized Loans, Direct PLUS loans made to students, and Direct Consolidation Loans that don’t include PLUS loans made to parents are eligible. Monthly payments will be recalculated each year; spousal income or loan debt is only considered if you file a joint tax return; and monthly payments are 10% of your discretionary income (but never more than what you would have paid with the 10-year Standard Repayment Plan). Over time, you’ll pay more than if you had the 10-year Standard Repayment Plan. Any outstanding balance after 20 years is forgiven; however, you may have to pay income tax on the forgiven amount.

    Income-Based Repayment (IBR) Plan payments are either 10% or 15% of your discretionary income, limited to the amount you would have paid under the 10-year Standard Repayment Plan. Borrowers need to have a high debt relative to their income, and they will usually pay more over time than if they had used the 10-year Standard Repayment Plan; however, any balance after 20 or 25 years is forgiven. If you’re married and file a joint tax return, your spouse’s income or loan debt will be considered when your payments are recalculated each year. Direct Subsidized and Unsubsidized Loans, Subsidized and Unsubsidized Federal Stafford Loans, all PLUS loans made to students and Consolidation Loans that are not Direct or FFEL PLUS Loans made to parents are eligible.

    The Income-Contingent Repayment (ICR) Plan is for Direct Subsidized and Unsubsidized Loans, Direct PLUS Loans made to students, and Direct Consolidation Loans, where your payment will be either 20% of your discretionary income or the amount you’d pay on a repayment plan with a 12-year fixed payment, adjusted for income, whichever is less. Payments are recalculated each year, and if you’re married and file a joint tax return or choose to repay Direct Loans jointly with your spouse, their income or loan debt will be considered. After 25 years, if there is still a balance, your debt will be forgiven; however, you may have to pay income tax on the forgiven amount. 

    Income-Sensitive Repayment Plan payments are based on your annual income, with your loan paid off in full within 15 years. You’ll pay more over time than under the 10-year Standard Repayment Plan, and the monthly payment can vary from lender to lender. Subsidized and Unsubsidized Federal Stafford Loans, FFEL PLUS Loans, and FFEL Consolidation Loans are the only eligible loans for this plan.

    With parent PLUS and grad PLUS loans, there are additional payment plans available. Parent PLUS loans have a fixed interest rate the life of the loan. For grad PLUS loans, the interest rate is also fixed for the life of the loan.

    Loan Payments


    There are four things to keep in mind when discussing federal loan payments:

    • Federal loans offer a 0.25% interest rate deduction for Direct Loans if you schedule an automatic monthly electronic debit of your loan payment from your checking or savings account.
    • If you are in a position to pay more than the amount due each month, paying extra can reduce the interest you pay, reducing the total cost of your loan. 
    • If you are having trouble making your loan payment, you may be eligible for a different repayment plan, deferment, forbearance, or loan consolidation.
    • If you have missed one or more loan payments, you may be able to apply for an income-driven repayment plan, forbearance, or deferment.

    As you calculate interest rates when comparing loans and repayment plans, there are many online resources available. Before getting into a 10- to 25-year commitment, however, it’s important to weigh all of your options to make the best choices possible. 

    If your student loans are not federal student loans, and instead are private student loans, the interest rates and loan terms are determined by your loan servicer. They can begin accruing interest while you’re in school, or after school, depending on your plan.

    Before you sign on the dotted line and choose a loan repayment plan, our team of experts at College Finance wants to make sure you have all of the knowledge first. Browse our latest guides and articles to answer any questions you may have.

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