Understanding student loan interest rates

You've been through the tests, applications, and nail-biting anticipation of getting into college or graduate school. And you may have spent a lot of time researching your options to figure out which school is the best fit. Fortunately, there's no big test for your next important decision—choosing your student loan and lender.

Learning how student loan interest works, how interest rates are determined, and what to expect can help you make an educated decision before accepting a loan offer.

Fixed vs. variable interest rates

When you apply for a private student loan, you may have the choice of selecting either a fixed or variable interest rate.

A fixed interest rate will remain the same throughout the life of the loan. It gives you the security of knowing how much you will pay each month, but could mean you pay more over the life of your loan because fixed interest rates generally start higher than variable interest rates depending on the economy. If you want predictable monthly payments and stability, a fixed interest rate may be the best option for you.

In contrast, a variable rate is an interest rate that may change periodically throughout the life of the loan. Variable interest rates are tied to an index. If the index changes, your loan’s interest rate will fluctuate with it.

The interest rate chart is for illustrative purposes only and does not reflect specific past or future performance.

Increases in the interest rate on a variable rate loan could impact your budget. If your interest rate increases, your monthly payments will increase, and that can be challenging to manage when you are balancing your monthly budget. However, if you know you will pay off your loan quickly, then a choosing a variable rate loan with a lower starting rate than a fixed loan may be a good option.

Changes in interest rate indexes can be hard to predict since all sorts of complex factors like the economy and inflation influence them. Since variable interest rate increases and decreases are unpredictable, your monthly payment may increase and decrease during the life of your loan.

How are interest rates determined?

Whether you're looking for a fixed or variable rate student loan, your interest rate will be determined after you apply. How the interest rate is calculated can depend on several factors.

Federal student loans have fixed interest rates. Federal law sets the rates, which vary depending on the type of loan and when you first receive your disbursement, but not your creditworthiness.

For private student loans, rates can vary depending on the lender and your creditworthiness, which may include your credit score, credit history, income, and other outstanding debt. These factors play a significant role in determining your eligibility for a loan and the rate you receive.

Having a creditworthy cosigner, especially if you don’t have an established credit history, may improve your likelihood for loan approval and may lower your interest rate. Even if you qualify on your own, you may receive a lower interest rate by adding a cosigner.

How does student loan interest work?

Most lenders allow you to postpone making payments while enrolled in school at least half-time and during your grace period. While you are in school and during your grace period, interest accrues daily. When it’s time to start making payments, the accrued interest is added to your principal balance—or capitalized. Your interest rate will apply to this new, larger principal balance. This will increase the amount of your monthly payment, total loan balance, and the amount of interest you pay back.

If you choose an in-school repayment option, you can reduce the amount of interest by making payments while in school and during your grace period. Regardless of which repayment option you choose, you can always make payments at any time with no prepayment penalty.

Choosing a loan that's right for you

With an understanding of key terms and concepts, and how student loan interest works, you can start evaluating private student loans and comparing lenders. To decide which lenders are a good fit, look at the loan options, APR ranges, fees, and additional benefits.