Interest Rates and Your Loans for Education

Why Rates Matter

The interest rates attached to your student loans are as important as the loans themselves. As interest accrues, or is added to the loan amount, so does the value of the loans, the amount you must repay.

Here is an example of an interest rate applied to a student loan:

You have applied for a federal unsubsidized Stafford Loan and are approved for $5,000. The interest rate on this loan is fixed at 6.8% (between 2007 and 2012 this interest rate will be incrementally cut to a final 3.4%). This means that, at 6.8%, $340 in interest is added to your loan each year. If you defer loan payments for four years until after graduation, your new amount owed on the loan will be $6,360. See? Once you start repayment you will make an extra $340 in interest payments above and beyond real loan value each year.

Student loan interest rates can vary by year and/or by type of loan. Sweeping changes to the Higher Education Access Act of 2007 have indicated a few interest rate deductions. But before you borrow you must understand how a loan’s interest rate will affect your final loan amount.
Student Loans with Interest

Most types of student loans come packaged with an interest rate, fixed or variable.

* The Stafford Loans borrowed since July 1, 2006 feature 6.8% fixed interest rates. The Higher Education Access Act of 2007 changed the rates: between 2007-2008 and 2012-2013 the interest rate will be incrementally reduced until it is finally set at 3.4%.
* Perkins Loan interest rates are fixed at 5%.
* Parent and Grad PLUS Loans interest rates are fixed at 8.5% for those borrowed since July 1, 2006 in the Federal Family Education Loan Program (FFELP), and at 7.9% for the same loans borrowed in the federal Direct Loan program.
* Private or alternative student loans feature variable interest rates that may start off low and increase over time, not unlike a credit card rate. Most sites state in fine print “rates may change without notice.”

Part of the financial burden of any kind of loan is the interest. Interest is the amount owed above and beyond the agreed upon loan. Interest is figured as a percentage of the loan total. Student loan interest can either accrue from the day the loan is disbursed or the first day of loan repayment, which in some cases is well beyond graduation.
Tax Benefits

The federal government has built in a money saving student loan interest tax deduction. A number of criteria apply: the loan must be a qualified student loan, which means it was intended only for college costs; and you must be responsible for repayment of the loan. A student is defined as enrolled in a post-secondary educational institution in a degree or certificate program. You may figure your interest rate tax deductions using the IRS Student Loan Interest Deduction worksheet.

Know Your Bottom Line Interest Rates and Fees

So how do you know how much interest you will be required to pay on your student loans? Most educational lending services or private banks that extend college loans, feature student loan interest rates and loan calculators on their websites.

Here are the critical interest rate questions you absolutely must ask before borrowing:

* Is loan interest fixed or variable?
* If variable what is the maximum?
* When will interest begin accruing?
* When will I be required to pay it?