How student loan interest works (and how to keep it under control)

If the idea of borrowing money for school makes your head spin, don’t worry — you’re not alone. This guide breaks down how student loan interest works, when it kicks in, how it’s calculated, and most importantly, how you can keep it under control while you’re here at UC and beyond.

At its core, student loan interest is the cost of borrowing money. When you take out a loan, you’re agreeing to pay back more than just the amount you borrowed — that extra amount is the interest.

Think of it like this: You borrow $1,000 from a friend and promise to pay them back $1,100 by the end of the year. The extra $100 is the interest. The bigger your loan, the more you’ll pay in interest.

Interest is typically calculated using this formula:

Interest = (Loan Balance x Interest Rate) ÷ Number of Days in the Year

Most federal loans use a simple daily interest formula, meaning the interest accrues daily and is based on your current loan balance and your loan's interest rate.

Here’s an example: If you borrowed $10,000 at a 5% interest rate:

• Daily interest = ($10,000 x 0.05) ÷ 365 = $1.37/day
• That adds up to about $41/month, just in interest.

For more details on federal loan interest rates, visit the Federal Student Aid website.

It depends on the type of loan you have.

• Subsidized federal loans: The government pays the interest while you're in school at least half-time, during the grace period, and during deferment.
  

• Unsubsidized federal loans: Interest starts accruing immediately, even while you're still in school.
  

So, if you're wondering, “Do student loans accrue interest in school?” The answer is yes, for most unsubsidized loans. If you’re not sure which loans you have, check with the Financial Aid Office or ask the team at Enrollment Student Services for help. And for more information on when your interest might begin, check out the Federal Student Aid: Interest page.

Not exactly. Interest actually accrues daily, but it’s typically added to your loan balance monthly. Once it’s added to your balance, that interest can become capitalized interest, meaning you’ll pay interest on a higher amount moving forward.

This is where things can get tricky. If you’re not paying attention, your loan balance can snowball, and you’ll end up paying more over time.

Capitalized interest is unpaid interest that’s added to the principal balance of your loan. It typically happens when:

• Your grace period ends
  

• You leave school
  

• You enter deferment or forbearance
  

Once interest is capitalized, you start paying interest on that new, higher balance, which can increase the total amount you owe.

Most students start with federal student loans, which tend to offer lower, fixed interest rates and more flexible repayment options.

Here’s a breakdown of all the student loan types:

Be sure to use a student loan interest calculator to estimate how much your loan could cost over time.

The principal is the amount you borrowed, while interest is the extra amount you’re charged for borrowing that money.

When you start making payments, your loan servicer usually applies your payment to interest first, then to principal. This means that paying just the minimum may not reduce your actual balance very quickly — especially early on.

That’s why it’s so important to understand the difference between student loan interest versus principal. If you can make extra payments or pay off the interest while you’re in school, it will save you money in the long run.

There are a few strategies that can help you minimize the long-term cost of your loans:

1. Make interest-only payments while in school: Even $10–$20 a month can keep interest from building up. Think of it like preventing a snowball from rolling down the hill and getting bigger over time.
   

2. Pay more than the minimum: Any extra payment you make will go toward reducing your principal, which helps you save on interest.
   

3. Set up automatic payments: Some federal loan servicers offer a 0.25% interest rate discount if you enroll in autopay. It’s a small savings, but it adds up over time!
   

4. Avoid deferment or forbearance if possible: These options pause payments, but interest usually continues to accrue, adding to your debt.
   

5. Refinance later (if it makes sense): Once you graduate and build credit, refinancing could help you secure a lower interest rate. But be careful, because refinancing federal loans means losing out on certain protections.

Here’s a quick overview of the student loan journey:

1. You accept a loan as part of your financial aid package.
   

2. Interest starts accruing (immediately for unsubsidized loans).
   

3. You’re in school — you may choose to make interest payments, but you’re not required to.
   

4. You graduate or drop below half-time — your grace period (typically six months) begins.
   

5. Repayment begins — you’ll start making monthly payments that include both interest and principal.
   

6. The loan is paid off — depending on your repayment plan, this can take 10–30 years.

Have more questions? Check out UC’s Student Loan FAQ for answers to common questions about borrowing, repayment, interest and more.

Understanding how student loan interest works puts you in control of your financial future. By making small but smart decisions now, like paying interest while in school or setting up autopay, you can minimize the impact of interest on your loan balance. Remember, it's not just about borrowing money—it's about making sure you’re prepared to pay it back in the best way possible.

Need help? Enrollment Student Services is your go-to resource for financial aid, loan counseling, and everything in between. They're here to help you navigate the process every step of the way.

Helpful Resources:

• Enrollment Student Services
  

• Federal Student Aid Website
  

• Student Loan Interest Calculator