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Whether you’re just starting college or are entering your senior year, chances are you’ve taken out student loans somewhere along the way. With many student loans, you aren’t required to make payments at all until about six months after you’re no longer enrolled in school full-time.

That’s a good thing, right? Well, maybe not.

In fact, making absolutely no payments on your student loans while you’re in school can mean that you graduate with a lot more debt than you expected. That’s because interest accrues on some of these loans while you’re still a student.

Did I lose you? Don’t worry. Here’s a quick primer on what all that means for you.

Understanding How Interest Works on Federal Student Loans

First, know that we’re mainly talking about federal student loans here. If you have private loans, they may work differently. Check your loan paperwork to find out.

When it comes to federal student loans, though, they fall into two main categories: subsidized and unsubsidized.

You have to meet certain income qualifications to get subsidized student loans. If you qualify, the government will pay the interest on these loans while you’re still enrolled in school. We’ll see in a moment why that’s advantageous.

On the flip side, the government does not pay interest on unsubsidized student loans while you’re in school, but you’re still not required to make payments.

On unsubsidized loans, interest is charged from the day the loan is issued. You can figure out this date from your loan paperwork. So if you have a loan with a 5% interest rate, that annual interest is charged starting on the issue date.

Most loan interest is compounded daily, meaning that the total interest rate is divided by the number of days in the year. Each day, the lender charges that amount of interest on the loan’s outstanding balance.

So if you don’t make any loan or interest payments while you’re in the grace period, your interest continues to accrue. The longer you go without making payments, the more interest will accumulate.

This, in and of itself, isn’t the end of the world. You can always catch up on interest payments once your grace period is over. However, capitalization can turn accrued interest into a huge problem.

At certain points in the life of your loan—like when your grace period ends or after you exit a period of deferment—any unpaid interest on the loan capitalizes. This means that the unpaid interest is added to the loan’s principal balance. Then your interest is calculated based on that new, higher balance. So not only do you have a higher balance to pay off, but your interest payments are higher each month, too.

Doing the Math

This is all kind of confusing, so let’s look at how the math breaks down.

Let’s say you take out a $10,000 unsubsidized federal student loan at 5% annual interest. You’ll pay 0.013699% interest daily. Doesn’t sound like much, but it comes out to about $1.37 each day. So over the course of a month, you’ll accrue roughly $42 in interest.

Again, that doesn’t sound like a lot of money, so what’s the big deal?

Well, play this out over the course of your college career. You take out this loan as a freshman, and you let interest accrue for your entire school career, including the six-month grace period after you graduate. Let’s say that totals 54 months.

In 54 months, your total interest accrued on the loan is around $2,268. If that interest capitalizes when your grace period ends, your principal balance is now $12,268. That means your daily interest is about $1.68, making your monthly interest about $51.

Again, it doesn’t seem like a huge amount of money. But multiplied by several years’ worth of student loans, it can really add up.

This is just a general example, though. You can use this calculator to determine just how accrued interest could affect your particular student loans.

Making Interest-Only Payments

Even if you can’t make full interest-only payments, paying what you can to reduce your loans’ capitalized interest is a smart idea. To figure out how to do this, just get in touch with your student loan servicer. Usually you can send in your payments online.

Since you’re not technically on the hook for paying off your loans, you don’t have to make payments every month. But if you come into some extra cash or get a paid internship, consider devoting some of your budget to paying off your student loan interest.

Student loans can be overwhelming, but paying off interest as you go is one way to pay less in the long run. If you have more questions on the best way to tackle your loans, check out these additional student loan resources for expert answers and guidance.

Image: Mixmike

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