Student loan interest rates and fees are charges that reimburse the lender for their efforts. Overall, they cause a borrower to pay more, while receiving less. Interest rates are added to the amount owed, making both it and future interest rates higher, while fees are subtracted from the amounts paid out, making the amount received lower than the amount borrowed.
All borrowers must pay back the principle amount lent plus interest rates and fees. However, a loan’s disbursement frequency and term ultimately determine how much a borrower will pay in additional charges. Fees and interest rates are accrued monthly, quarterly or yearly and attached to every disbursement or payment.
A borrower with annual loan disbursement will ultimately have a smaller total amount than someone loaned the same principle with monthly disbursement. Loans with longer terms will have smaller payments. However, the borrowers with shorter loan terms will have smaller total amounts.
For any borrowed money, there is a price to be paid in exchange for the funds. This is the interest payment on loans to the lender. Interest can be fixed or variable with a fixed rate margin. Fixed interest rates are set percentages that do not fluctuate for the lifespan of a loan. The fixed interest rates of federal student loans are set by Congress and guaranteed by the government.
Most private student loans have variable interest rates that are set by a lender and can potentially fluctuate on a monthly basis. Variable interest rates are usually attached to either the London Interbank Offered Rate or the PRIME index. LIBOR rates tend to increase more slowly and can be the safer of the two indexes. These rates represent what it costs a lender to borrow money and usually change on a monthly or quarterly basis. However, PRIME rates are usually reserved for established customers with the best credit.
These are up-front interest charges attached to loan services, such as origination and disbursement. Up-front interest is automatically deducted from principle loan amounts, causing students to receive less than what they actually borrowed. Origination fee is one-time charge at the start of a loan for the cost of processing and lending funds, whereas disbursement fees are charged every time an amount of the loan is paid out to the borrower.
There are also punishment fees for late payments and defaulted loans. Late fees can be up to 6 percent and are charged to every delayed payment. When payments haven’t been made for an exceptionally long time and a loan goes into default, collection fees are added to pay the collector and could be up to a 30 percent deduction from the principle loan amount.
Keeping Interest Down
Most private and federal student loan programs allow student to defer from making payments on their loans until after graduation. However all education loans let borrowers make prepayments on loan balances without being penalized by any extra fees. Making payments before a loan enters repayment opens the door for many opportunities to cut the cost of interest and save on total expenses.
Prepayment works to reduce the term of a loan by increasing the monthly payment amounts. These extra payments can reduce the balance of a loan or pay off an entire balance early, ultimately saving on total cost by reducing interest payments.
When a borrower has more than one loan, the loans with the highest interest rates should be targeted first in order to save the most money. Student credit cards usually offer the largest limits available, but come with the most expensive interest rates. These should be targeted first, followed by private loans and then federal student loans.
Lenders are allowed and usually apply prepayments to future installments. This allows the principle loan balance, term and interest rates attached to it to stay the same. For this reason, any prepayment should have a note indicating that it’s meant to be applied to the principal balance.
Avoiding Interest Capitalization
Making prepayments on at least any accumulated interest will prevent the principle loan balance from growing any larger while in deferment. Interest capitalization occurs when accrued interest is added to a loan balance once the loan enters repayment, causing an increase in the borrower’s overall debt and in monthly payments.
This form of negative amortization can easily be avoided by paying off any interest as it accrues during in-school deferment and grace periods. Avoiding interest capitalization will help borrowers keep their total costs down and pay off their loans faster.
Electronic Debit Account Discount
Majority of private and all federal loans offer a .25 or even .50 percent reduction on a borrower’s interest rate when monthly loan payments can be automatically taken from a checking or savings account.
Continued on Page 2