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Jon O'Donnell Updated on June 8, 2017

Interest is the price you pay for borrowing money. It sounds simple enough, but student loan interest rates can be complicated. The National Student Loan Union has put together everything you need to know about student loan interest rates. Read on to find out what the fine print means, how interest rates are determined, and how to score the lowest rate when refinancing college debt.

Student Loan Vocabulary

  • Principal – The original amount of your loan, without any interest or fees.
  • Interest – The cost of borrowing money. It is calculated as a percentage of your principal and is usually charged monthly.
  • Repayment term – The period of time over which you will pay back your loan.
  • Lender – The institution that provides the funds for your loan.
  • Servicer – Some lenders have a servicer that handles payments and acts as an intermediary between the lender and borrower.
  • Fixed interest rate – An interest rate that stays the same. It is determined at the beginning of the loan, based on market conditions or Congressional action, and does not change.
  • Variable interest rate – An interest rate that can rise or fall during the loan period, based on shifting economic conditions. Variable interest rates typically start out lower than fixed interest rates, but they’re riskier for borrowers because they can rise. Some lenders adjust their variable rates every three months; others change them monthly. Some loans have caps that limit how high the rate can go.
  • Cosigner – A second person, usually a family member, who accepts responsibility for the loan if the original borrower fails to pay.
  • Capitalization – When accrued interest is added to loan principal. This happens when people defer payments, or pay less than the monthly interest. It increases the total amount owed.
  • Consolidation – Combining multiple loans into one new loan with a single monthly payment. It may or may not have more favorable terms.
  • Refinancing – Paying off old debts with a new loan that usually has more favorable terms.
  • Income-based repayment – A federal repayment option for some borrowers that limits monthly payments to 10 percent of their discretionary income.
  • Deferment – A period of time during which eligible borrowers can postpone loan repayment. Loans may or may not accrue interest during deferment.
  • Forbearance – Some people who experience economic hardship may qualify for a forbearance, which allows them to stop making payments for a period of time. Interest accrues during forbearance.

How federal student loan interest rates are determined

People often assume that government loans have the lowest rates, but that’s often not the case. Congress sets federal student loan interest rates each year, based on financial market conditions and other economic factors. Rates vary depending on the loan type and the year the loan is originated, but the rates are fixed and are the same for all borrowers regardless of their credit history. Federal rates are often higher than private rates because the Department of Education has to account for high-risk applicants who are more likely to default or not finish their degrees. For most federal loans, graduate students are charged more than undergrads. 

How private student loan interest rates are determined

Banks and other lenders set their interest rates based on market conditions and risk. Rates vary based on the borrower’s credit history, the length of the loan, and the type of interest (fixed vs. variable), but are generally loosely related to the Federal Reserve’s prime interest rate or the London Interbank Offered Rate. Private lenders are often able to offer lower rates than the government because they can be selective about their borrowers. Not everyone who applies is approved. Generally, the better your credit, the lower the interest rate you’ll receive.

Factors that affect your interest rate

Lenders consider a variety of factors when deciding how much interest to charge you. Ultimately, it comes down to risk and how likely you are to pay back your debt. Among the things lenders look at are your FICO score, employment history, debt-to-income ratio, and expenses such as housing costs, car payments, and credit card debt. Your interest rate can also vary depending on whether you have a cosigner. In some cases, you can get a better rate by having a family member or spouse guarantee your loan.

How student loan amortization works

Even if your student loan payments are the same amount every month, the portion that goes to principal and the portion that goes to interest change over the life of the loan. When you first start making payments on your student loans, a larger percentage of your payment goes toward interest, and a smaller portion goes toward your principal. In some cases, you might not be paying anything toward principal. However, as you continue making payments, those percentages flip. By the end of your loan term, the majority of your payment is applied to your principal.

How deferment, forbearance, and income-based repayment affects interest

Sometimes, borrowers can postpone student loan payments or make lower payments immediately after graduation or during periods of economic hardship. Although these adjustments can be helpful to graduates who are not yet established in their careers, they come at a cost. During deferment, some loans accrue interest, and some don’t. However, all loans accrue interest during forbearance. When interest accrues, it gets added to the principal through capitalization (also known as negative amortization). Borrowers in this scenario may later have to pay interest on the interest. This can also happen with income-based repayment plans when people pay less than the interest charged.

How federal consolidation affects your interest rate

The U.S. Department of Education has a Direct Consolidation Loan that can bundle your federal debts into a single bill. The benefit is that you can simplify your college debt while remaining eligible for some federal repayment and loan forgiveness benefits. However, private loans are not eligible and it does not lower your interest payment. In fact, your interest rate might go up a bit. The government uses a weighted average of the underlying interest rates, which is rounded up to the nearest eighth of a point.

How private refinancing affects your interest rate

Refinancing is the only way to lower the interest rate on a pre-existing loan. Both private and federal loans can be refinanced with a private lender, and usually replaced with a new loan that has much better terms. A recent analysis by the National Student Loan Union found that people who refinanced student loans saved an average of $259 a month and $19,231 over the life of the loan. Some borrowers saved more, and some less, depending on the size of their debt and their credit histories. However, the average savings were significant.

How to get the lowest interest rate on your student loans

Chances are, there wasn’t much you could do about the interest rate when you first took out your student loans. However, graduates who have been out of school for a little while are in a much better position to renegotiate. The best way to get a low rate on your student loans is to build up your credit and then refinance. Having a steady job, a good credit score, and a low debt-to-income ratio will qualify you for the best deals. It’s also a good idea to shop around with different lenders. Although most private lenders have similar underwriting criteria, there are subtle differences. If you want to refinance, but your credit isn’t as strong as you’d like, consider applying with a cosigner who has a high FICO score.

A simple way to see if you could get a lower interest rate

Curious about whether you could get a lower interest rate by refinancing? There’s no need to wonder. Most modern student loan refinancing companies have online applications that take less than 15 minutes to complete. You can get an instant decision with no application or origination fees, and there’s no need to worry about the effect on your credit. The initial inquiry is considered a “soft pull” and does not impact your score.

There are dozens of companies that specialize in student lending, but not all are created equal. As part of our mission to help students and their families manage education costs, the National Student Loan Union regularly review lenders. The following are the companies we consider the nation’s best banks for student loan refinancing, based on their interest rates, transparency, product offerings, ease of applying, and customer service.

If you want to pay less interest on your student loans, we recommend that you start here:

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