App version: 0.1.0

3 Steps to Calculating Student Loan Interest

How to Calculate Student Loan Interest - Step-By-Step
Rebecca Safier
Rebecca SafierUpdated September 12, 2022
Share this article:
Editor’s note: Lantern by SoFi seeks to provide content that is objective, independent and accurate. Writers are separate from our business operation and do not receive direct compensation from advertisers or partners. Read more about our Editorial Guidelines and How We Make Money.
When you borrow a student loan to pay for school, you must pay back the amount you borrowed and the interest charges that come with it. In the 2021-22 year, for example, federal student loans charge rates between 3.73% and 6.28%, depending on your year in school and type of loan. The government uses a simple daily interest formula to calculate interest on federal student loans. Here’s how to calculate student loan interest on your own loans. 

How to Calculate Student Loan Interest Rates

Some students focus on getting a scholarship or pursuing grants so that they don’t have to take on loan debt.If you do decide to take out loans, It’s important to take the time to really figure out how student loan interest works. Interest typically accrues on student loans on a daily basis. When you make a payment, part of your payment goes to interest and fees and the other part goes to paying down your balance.  There are many aspects to take into account, such as student loan interest deduction.Also, interest and payments have been paused on federal student loans since March of 2020 in response to the COVID-19 pandemic. If and when interest and payments resume, here are the steps you can take to calculate student loan interest. 

Step 1: Calculate the Daily Interest Rate

You can start by calculating your daily interest rate. To do this, divide your interest rate by 365 (the number of days in a year). Let’s say you have a $25,000 loan at a 5% interest rate. Your calculation would look like this: 0.05 (interest rate) / 365 = 0.000137

Step 2: Identify Your Daily Interest Charge 

Once you know your daily interest rate, you can multiply it by your principal balance to find your daily interest charge. In this example, your balance is $25,000. 0.000137 (daily interest rate) x $25,000 (principal balance) = $3.43That’s the amount of interest your student loan is accruing on a daily basis. 

Step 3: Convert It Into a Monthly Sum

Finally, you can multiply your daily interest charge by 30 to see how much interest will accrue in a month. So $3.43 (daily interest charge) x 30 (days in a month) = $102.90In this example, you’ll pay $102.90 every month in interest. If you’re paying this loan off over 10 years, your monthly payment would be $265. Based on these calculations, $102.90 of your first payment would go to interest and $162.10 would go to paying down your principal balance. 

Understanding Amortization 

In this example, more than $100 of your first monthly student loan payment would go to paying off interest charges. But that amount won’t stay the same due to your student loan amortization schedule. The amortization schedule refers to the process of paying back a loan with fixed monthly installments. As you pay off your balance over time, less of your monthly payments will go toward interest charges and more will go toward your principal balance. 

Interest Can Capitalize on Student Loans 

It’s also worth noting that interest can capitalize on student loans, or be added to your principal balance. Capitalization can make your loan more expensive, because you’re essentially paying interest on top of interest. There are a few circumstances when interest capitalizes, including when your grace period or another period of deferment ends or when you depart certain income-driven repayment plans. To prevent interest capitalization, consider making interest-only payments while you’re enrolled in school. Even though payments aren’t due, covering the interest charges can prevent your balance from ballooning after graduation. 

How to Calculate Compound Interest on Loans

While federal student loans use a simple interest formula, some private lenders use a compound interest formula to calculate student loan interest. With a compound interest formula, your daily interest charges can be added on to your balance every day. Let’s go back to the example of the $25,000 at a 5% rate. With a compound interest formula, that $3.43 would be added to your balance the next day. As a result, Day 2’s interest would accrue on a balance of $25,003.43, so the charge would be even higher — and increase on a daily basis.As you can see, compound interest can cost you significantly more than simple interest. Some private student loans also have variable interest rates, which can change over time depending on market conditions. 

Paying Down Your Student Loans

Naturally everyone would like to figure out how to pay down their loans or at least get lower student loan interest rates. There are programs you can investigate, such as employer student loan repayment.If you qualify, refinancing could reduce your interest rate on your student loans, so you’re not wasting as much money on interest charges every month. 

The Takeaway

Knowing how to calculate student loan interest can be empowering. Once you see how much interest is accruing on your student loans on a daily basis, you might feel motivated to lower your interest rate.If you have federal student loans, however, it’s important to note that one of the disadvantages of refinancing student loans with a private lender is losing out on government programs. As a result, you’ll no longer be eligible for federal repayment plans, forgiveness programs, or other protections. Make sure you thoroughly understand how refinancing your student loans works before you pursue it.If you decide the benefits of refinancing outweigh the cons, Lantern can help you compare student loan refinancing options
Photo credit: iStock/FluxFactory

Frequently Asked Questions

Can I deduct student loan interest on my taxes?
When should you consolidate for a better rate?
Who sets rates for federal student loans?

About the Author

Rebecca Safier

Rebecca Safier

Rebecca Safier has nearly a decade of experience writing about personal finance. Formerly a senior writer with LendingTree and Student Loan Hero, she specializes in student loans, financial aid, and personal loans. She is certified as a student loan counselor with the National Association of Certified Credit Counselors (NACCC).
Share this article: