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Interest Accruing Mechanism for Federal Loans


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Hi everyone,


It's my first time taking federal loans. This question may be stupid or may have been asked before, but here you go: I'm going to a school whose academic calendar goes in quarters; therefore, the total amount of money that I am borrowing from the federal government will be paid out to me in three installments over the course of the next year, and not a single one before the year even starts. It is my goal to pay interest off as it accrues at the end of every month, so it doesn't capitalize. I've been wondering: Does interest accrue over the entire amount you were approved for right off the bet or does it accrue only over amounts already disbursed to you at the points where it is calculated (at the end of every month)?


In my mind, it does not make sense that interest always accrues over the entire amount I was approved for, since only 1/3 of it will have been disbursed before the first quarter starts, for example. In this example, shouldn't it accrue over only 1/3 of the entire amount for the first three months? Since I am unfamiliar with the rules of federal loans, though, I thought about asking.


Just in case that information is relevant, the loans I am planning on taking are the Unsubsidized Stafford and Graduate PLUS ones.


Thanks a lot for any help! :D

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It accrues over what's been dispersed and it accrues daily


More information available here: https://studentaid.ed.gov/sa/types/loans/interest-rates




How is interest calculated?
The amount of interest that accrues (accumulates) on your loan from month to month is determined by a simple daily interest formula. This formula consists of multiplying your loan balance by the number of days since the last payment times the interest rate factor.

Simple daily interest formula:

Outstanding principal balance
x number of days since last payment
x interest rate factor
= interest amount
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Just to be clear--the accrued interest only capitalizes once you graduate / go out of deferment right? See: http://www.myfedloan.org/help-center/faq/interest-faq.shtml


If so, because it is "simple" interest like rising_star said, you do not have to pay off the accrued interest every month because while you are in deferment, the interest does not capitalize so you don't get charged interest on the accrued interest. For example, if you are in deferment for 2 years, you would pay the same amount of accrued interest (and avoid capitalization) whether you pay off your accrued interest in 24 monthly payments, 2 annual payments, or all at once prior to the end of deferment (when you receive your Interest Notice). 

Of course, setting aside money each month would be a good idea to avoid being unable to pay all of the accrued interest at the end. But since it makes no difference when you pay, if you are in a long program, it might be even better to either: 1) set aside that money and invest it so that you can earn interest or 2) add it to your savings and reduce the amount of future loans you have to take. 

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Graduate student loans are no longer subsidized so interest begins accruing after you take the loan out, even though you don't have to make any payments until 6 months after graduation. What many people do is pay the interest as it accrues to avoid having to come up with a lump sum at the end of the deferment period to avoid capitalization. If you look at the example in the link TakeruK provided, you'd have to be paying the interest while in school to avoid having it capitalize. The example on the right side of that table is if you've been paying the interest while in school.


I'm going to disagree with Takeruk's advice though. Right now, savings accounts interest rates are paltry (less than 1%). While you have the chance to make more money by investing in the stock market, you also may not (the 5-7 years of a Ph.D. program is not long-term by stock market standards). If you were to invest the money and lose it, then you'll be even further away from avoiding capitalization. The only semi-safe investment would be a savings bond or certificate of deposit (CD), which have interest rates under 3% right now...

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I guess what I mean is in the table linked, $5700 is the accrued interest over the course of an example degree (a little over 4 years at 6.8% per annum) so whether you paid that in 48 monthly installments or a lump sum at the end, it won't matter right? 


In this example with $20,000 loan, the accrued interest after 1 year is $1360. At this time, you could choose to pay the $1360 right now (or maybe you would have already paid it in 12 installments). Or, you can invest it in something like a CD (I was thinking this rather than the stock market, sorry if "invest" wasn't the right word, because I agree, grad school timescales are not long term investments) and earn 3% on it until you have to pay it back. 3% per annum for a couple of years would not be that much on $1360, just a few hundred dollars but that could be about one monthly payment. 3% is not a lot, but it's a lot more than 0% you get from paying back right away.


Or, you can "invest it in yourself" and let's say you put $700 towards a CD intended to pay off the interest later on and $700 towards your savings so that you take out $700 fewer in loans the following year. If you do this, when you go out of deferment, you will have an extra $700 applied towards your principal and you will be paying interest on that starting on the first day of deferment. However, by reducing the second loan by $700, you are saving yourself from having to pay interest on that $700 for the last 4 years of your program. 


These numbers are based on that example table, which is a $20,000 loan for a 4 year degree program. They would have to be scaled to match the actual loan needed. Maybe after doing so, the difference in how much you would have to pay is so small that it's not worth all of the hassle, or perhaps the student is the type of person that budgets better if they just pay off interest in monthly installments. I'm not saying that this way is the best for everyone, but it's worth considering :)

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  • 2 weeks later...

rising_star and TakeruK, thanks for your responses and insights! I really understand how things work and feel better prepared to design the best payment plan for me now!  :)

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