The power of student loan interest rates
The interest rate you'll pay on various college loan options is one of the single largest factors when selecting the right mix of student loans to help you pay for your education.
There are two broad types of interest rates—fixed and variable. Fixed rates do not fluctuate, but remain stable for the life of the loan. Variable rates fluctuate based on the broader economy and Federal Reserve policies.
Private college loan interest rates are typically variable and therefore fluctuate with the economy and can adjust monthly or quarterly throughout the year. Federal loan rates are set by the Federal Government and instituted on July 1st of each year, and are usually several percentage points lower than those offered by private lenders such as banks or credit unions.
Pay attention to the APR
Look beyond just the interest rate. One effective way of making valid comparisons between competing loans is to check the APR (annual percentage rate) of the loan. You'll want the lowest possible APR you can get. An APR includes the annual cost of an education loan, including interest and any fees, expressed as a percentage.
How student loan interest works
Here's one example of how interest rates work in the context of student loans (please note, this may vary by lender):
Let's pretend the remaining balance on your loan is $9,500.00. Thirty-two days after your last payment, you sent in a payment of $160.00. Your interest rate is 8.25%. Divide the interest rate by the number of days in a year (365.25) to get the interest rate factor; in this example, it’s .00022587.
To determine the amount of interest you'd be required to pay each month, you can use the following formula (remember that interest accrues daily on most student loans):
Number of days since your last payment
Principal balance still outstanding
Interest rate factor
32 days times $9,500.00 (principle balance outstanding) times .00022587 (the interest rate factor) means you would pay $68.66 toward interest and $91.34 toward the principal balance, under this example. This would leave you with a loan balance of $9,408.66.