If your grace or separation period is ending soon, you’re probably gathering all your loan information to stay on top of everything. You open your lender’s website and see that the amount you owe is way more than you had borrowed. Let’s clear up the confusion and talk about why this is the case.
The basics of interest rates
The main reason you are paying back more than you borrowed is interest, the amount you’re charged from a lender who took the risk of lending you the money. A Sallie Mae study, Majoring in Money, found that a quarter of young adults don’t have an understanding of how interest rates (the percentage of interest you agree to pay to borrow money) work. Knowing the facts on student loan interest rates is crucial to understanding the amount you have to pay back.
Interest accrues–even while you’re still in school
Having loans does not mean taking out a certain amount of money and paying that same amount back. Interest starts to accrue (grow) as soon as you take out the loan and it continues to add to the amount you’ll have to pay back. An example of interest accrual is if you borrow $100 at 5% interest, you’ll need to pay back $105. The exception is a subsidized federal student loan; the government pays the interest while the student is in school, grace period, or deferment.
Also, capitalization causes your principal, or original loan amount, to increase. Capitalization is when any unpaid interest becomes part of your principal. What this means is any unpaid interest is added to your total loan amount, so you are essentially paying interest on top of interest.
Interest rates aren’t created equally
Student loans should not be treated the same across the board. Let’s say you have federal loans and private loans. Repayment for these loans can look completely different. A big reason for this difference is how interest rates affect the amount you have to pay back.
- Federal student loans have a fixed interest rate that is set by the government each year. This interest rate stays the same for the timespan of your loan.
- Private student loan interest rates can differ among lenders. The interest rate is set by the loan servicer and may be fixed or variable. A variable interest rate can go up or down depending on how the economy is doing.
What to do if you can’t pay back your loans
If you’re having trouble paying back your student loans, there may be alternative options. Depending on your loan servicer, you may have options to temporarily lower or pause your loans.
Keep in mind that federal student loans and private student loans each have different repayment options. Federal student loans offer temporary relief options and programs for special situations. For private student loans, contact your loan servicer to know exactly what your options are.
Remember that student loans are not all the same. Stay on top of your student loans to keep your personal finances in check.