When you receive a private or federal
student loan, you will be required to pay back the principal amount of your loan plus
interest, or a certain percentage of the amount that you borrowed. Since
interest rates will greatly impact the amount you will eventually have
to pay, it is important you known who sets your interest rate, how interest
is calculated, and any fees that will be associated with your loan.
Direct Loans vs. Private Student Loans
Direct Loans from the United States Department of Education have interest
rates that are determined through legislation according to financial markets,
with new interest rates being determined every spring for the upcoming
academic year. All interest you pay on these loans goes directly to the
U.S. Treasury and cannot be changed by your loan servicer.
Types of direct loans include:
- Direct subsidized
- Direct unsubsidized
- FFELP Unsubsidized
- Direct PLUS loans
- FFELP PLUS loans
Although loans under the Federal Family Education Loan Program (FFELP)
are no longer being made, these loans were also subject to a congressionally-determined
maximum interest rate which stayed consistent throughout the life of the
loan. Generally speaking, undergraduate students are charged the least,
while graduate and professional students are charged more.
Private loans, on the other hand, have interest rates that are established
by the lender that made the loan and are primarily based on your credit
history and that of your cosigner, if you have one. Depending on the contract
you sign at the beginning of your loan, these interest rates may be variable
or fixed. In some cases, private lenders may offer borrower benefits which
allow you to achieve a lower interest rate, such as paying consistently
or setting up a recurring automatic pay system with your bank.
What Is Capitalized Interest?
If your loan is set up to where you accrue interest while you are in school,
such as with a Direct Unsubsidized or private loan, you will have capitalized
interest if it is unpaid. In other words, you will have to pay interest
on both the principal amount and on the interest that has already accumulated.
Paying off the interest during college can minimize this effect and allow
you to start to pay off the original balance minus any fees upon graduation.
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