It Pays to Develop an Interest in Interest Part 3

The Power of Interest: Reduce Your Long-term Costs

Paying for college is in your reach. In addition to grants and tax credits, there are several types of educational loans available for individuals pursuing a post-secondary degree. The most common categories are: student loans, parent loans, and private student loans.

Since July 1, 2010, all new federal education loans have been made through the Direct Loan program. The loans are made through the college’s financial aid office with funds provided by the US Department of Education.⁷ These loans include the Federal Parent PLUS loan in addition to student loans.

The common interest tying all these loans together is interest. The interest rates on Federal education loans change on July 1, and are based on the 91-day rate from the last Treasury auction in May and the average one-year constant maturity Treasury yield (CMT) for the last calendar week ending on or before June 26th.⁸ Furthermore, the College Cost Reduction and Access Act of 2007 cut the fixed interest rates on newly originated subsidized Stafford loans for undergraduate students to 6.0% (2008-09), 5.6% (2009-10), 4.5% (2010-11) and 3.4% (2011-12), with a return to 6.8% in 2012-13. These cuts are available only to undergraduate students, not graduate students, and only for subsidized Stafford loans, not unsubsidized Stafford loans. Those loans remain at a fixed rate of 6.8%.⁹

Simply put, the less interest you have attached to your loan, the less your monthly financial obligation.

What this Means to You as a Borrower

A school loan is not free money. You are obligated to pay it back. Pay attention to how much you borrow, your interest rates, and the terms under which you must pay it back. Anticipate your post-graduation repayment obligations and plan accordingly. Yes, federal loans have a grace period after you graduate, leave school, or drop below half-time enrollment before which you have to begin repayment: six months for a Federal Stafford Loan or nine months for a Federal Perkins loan.¹⁰ However, just because there is a grace period, does not mean it’s necessarily in your best interest to take it.

One way to keep track of your school loans, and your overall college debt obligation, is to pay the interest on student loans during the in-school grace period. Lenders still charge interest on unsubsidized loans during in-school deferment, but the unpaid interest is added to the loan balance, causing the loan to get bigger. This leads to a larger monthly loan payment when you begin repaying the loan. Borrowers who make partial monthly payments during the in-school deferment will save a lot of money over the life of the loan as compared with borrowers who don't make any payments. Ideally, if you can, make payments of at least the new interest that accumulates each month during the in-school and grace periods.¹¹