Here’s what you need to know about the costs associated with federal student loans.
Image source: Getty Images.
Like any other type of loan, federal student loans eventually need to be repaid with interest. Federal student loans have fixed interest rates, meaning that they stay the same for the life of the loan, but the interest rates given to newly-originated student loans change from year to year.
With that in mind, here’s a guide to the current student loan interest rates, how these and future student loan interest rates are determined, and how these are used to calculate the amount of interest you’ll actually pay.
Interest rates for 2018-2019 school year
Here’s the short answer. Federal student loans disbursed during the 2018-2019 school year have the following fixed interest rates:
- 5.05% for undergraduate student loans (unsubsidized and subsidized have the same rate)
- 6.60% for graduate student and professional loans
- 7.60% for PLUS loans made to parents and graduate students
However, there’s more to the story. In the coming sections, we’ll go through how these interest rates are determined, how they’re used to calculate your interest, and the other major expense of federal student loan borrowing you need to know.
How are federal student loan interest rates determined?
As mentioned, the interest rates in the previous section only apply to the 2018-2019 school year. Specifically, this means that these are the interest rates on direct loans first disbursed on or after July 1, 2018, and before July 1, 2019. Any direct loans first disbursed after July 1, 2019 will be considered as part of the 2019-2020 school year.
Prior to the 2013-2014 school year, federal student loan interest rates were set by Congress, and while they were generally reflective of market interest rate conditions, there wasn’t a specific formula.
Now, federal student loan interest rates are determined by the high yield of the 10-year U.S. Treasury note as of the latest auction before June 1 of each year. A certain percentage is added to this, depending on the type of loan, and the total of these two percentages becomes the federal student loan interest rate for the upcoming school year.
To illustrate this, here’s a more detailed version of the 2018-2019 school year’s interest rates. On May 9, 2018, the 10-year Treasury note auction resulted in a high yield of 2.995%. For the three main categories of federal student loans, add-ons were applied as follows:
Type of Federal Student Loan
10-Year Treasury Note Yield
Student Loan Interest Rate for 2018-2019
Data source: Federal Student Aid.
Because they are tied to the 10-year Treasury note’s spring interest rate, the interest rates for federal student loans disbursed during the upcoming school year are typically announced in May.
It’s also important to mention that there’s an upper limit on federal student interest rates. No matter how high the benchmark 10-year Treasury note yield climbs, the maximum federal student loan interest rates are set at 8.25% for undergraduate loans, 9.5% for graduate loans, and 10.5% on parent loans.
If you want to know what federal student loan interest rates were in effect prior to the 2018-2019 school year, the Department of Education maintains a list of historical interest rates on its website.
On the other hand, private student loan interest rates are governed only by the companies who issue the loans and the borrower’s credit qualifications.
How your student loan interest is calculated
Your interest rate is used to calculate your student loan interest that you pay on each monthly payment. It’s a popular misconception that you pay the same amount of interest on each of your payments, and that isn’t necessarily true, even if your principal balance stays the same.
Here’s how it works. First, your student loan’s interest rate is divided by the number of days in the year to determine your interest rate factor. For example, if your interest rate is 5.05% and there are 365 days in the current year, your interest rate factor is 0.0138%.
Next, your outstanding principal balance is multiplied by this factor, and then is multiplied again by the number of days since your last payment.
So if you owe $10,000 on student loans with a 5.05% interest rate, and 30 days have passed since your last payment, the formula shows that your accrued interest is $41.40.
Subsidized vs. unsubsidized: How interest works
One important distinction is how interest on student loans differs between subsidized and unsubsidized loans.
First, although subsidized loans were formerly available to graduate students, they are now only available to undergraduate borrowers. And ever since the new interest rate rules went into effect in 2013, subsidized and unsubsidized loans have the exact same interest rates.
The difference is what happens to the interest that accumulates during certain time periods. Specifically, any interest that accrues on your subsidized student loans while you’re in school, during the six-month grace period after you leave school, and during periods when your loan is in deferment.
In other words, if you have a $5,000 subsidized student loan and, based on the calculation method discussed earlier, $100 worth of interest has accrued while you’re in school, your loan balance will still be $5,000. The government will cover the interest payment.
On the other hand, the interest that accrues on unsubsidized loans is always your responsibility. To be clear, you won’t have to make payments on your federal student loans while you’re in school, but unless they’re subsidized, the interest is accumulating.
What if your interest is more than your monthly payment?
There are several possible situations where your required monthly payment on your student loans aren’t enough to cover the interest that accrues.
For example, I’ve already mentioned that interest accrues on unsubsidized loans while you’re in school. In this case your required monthly payment is $0, but your interest expense due to accrued interest, is not. Another situation is if you’re on an income-driven repayment plan, and your required monthly payment is less than the amount of interest that accrues between payments.
In situations like these, there are a few rules to know:
- At the end of a deferment period, or your six-month grace period, any unpaid interest that has accumulated on your unsubsidized loans is generally capitalized, which means that it’s added to your principal balance. This is also true of any unpaid interest if you leave an income-driven repayment plan.
- As long as you remain in an income-driven repayment plan and qualify for a reduced payment based on your income, your unpaid interest will not be capitalized (yet). However, on unsubsidized loans, it will continue to accrue but won’t be a part of the principal balance.
- Finally, unpaid accrued interest on subsidized loans is typically covered by the government.
Don’t forget about the loan fee
As a final point, it’s important to mention that interest isn’t the only expense associated with federal student loans. You’ll also have to pay a “loan fee,” which is an origination fee that is deducted from your student loans when they’re disbursed.
The fees change slightly each year, but for the two most recent years, they are:
First Disbursement 10/1/17-9/31/18
First Disbursement 10/1/18-9/31/19
Direct Subsidized and Unsubsidized
Direct PLUS Loans
Data source: Department of Education.
As an example, let’s say that you’re a graduate student and you obtain a $10,000 Direct Unsubsidized Loan, which was first disbursed in August 2018. The 1.066% fee would be deducted from your loan proceeds, so a total of $9,893.40 would be disbursed to your school on your behalf.
The Motley Fool owns and recommends MasterCard and Visa, and recommends American Express. We’re firm believers in the Golden Rule. If we wouldn’t recommend an offer to a close family member, we wouldn’t recommend it on The Ascent either. Our number one goal is helping people find the best offers to improve their finances. That is why editorial opinions are ours alone and have not been previously reviewed, approved, or endorsed by included advertisers. Editorial content from The Ascent is separate from The Motley Fool editorial content and is created by a different analyst team.