Demystifying Paying Back Student Loans

Graduating from college is an exciting accomplishment, but it can also feel a little scary. Going out into the real world, finding a job and start paying back those pesky student loans, along with all your other bills, seems overwhelming.

The problem? The world of student loans can be pretty confusing, especially for those just getting started or a little ways in. Don't worry, though. We've got the answers to some of the most common questions around student loans and repayment.

Why do different student loans have different rates?

There are a few reasons why student loans have different interest rates. The biggest factors have to do with the loan type and when it is borrowed.

Federal student loans come with fixed interest rates that are set by the government.1 These rates are determined by legislation and can change yearly. Different rates are set for undergraduate loans, graduate or professional unsubsidized loans, and graduate or parent PLUS loans.

Regardless of your interest rate, once you take out the loan, the rate stays fixed for the entire term and your monthly payment remains the same amount until the loan is paid off.

Private student loans, on the other hand, have interest rates that are determined by individual financial institutions.2 They can be fixed or variable, meaning the rate can go up or down according to market conditions. In general, interest rates on private loans tend to be higher than federal loan rates.

Why do the interest rates on some of my loans keep changing?

Unlike fixed-rate loans, where the interest rate remains the same over the loan term, variable-rate loans have interest rates that are tied to an index or benchmark rate (such as the prime rate).3 As these benchmark rates fluctuate based on economic conditions, the interest rates on variable-rate loans will change accordingly.

Variable-rate student loans are common among private lenders. The rates may start off low and seem like an attractive option when you take out the loan. However, the rate can increase significantly over time and leave you with unaffordable payments.

Is there any way to refinance variable-rate loans so the rate stays the same?

Yes, it is possible to refinance a variable-rate student loan to obtain a fixed-rate loan instead.4 Refinancing essentially involves taking out a new loan with different terms and using that loan to pay off the existing student loans. If you can qualify for a different loan with a lower, fixed interest rate, it may be worth pursuing.

However, it's important to do some math and make sure that refinancing makes financial sense. There could be fees involved, which wipe out some of those interest savings. And if you decide to extend the length of your repayment term, you could end up paying more interest over the life of the loan, even if the rate is lower.

How is the amount I owe on my student loan calculated?

The total cost of a student loan consists of the principal amount borrowed, plus the accrued interest and potentially any fees charged by the lender.

As you make payments, the amount you owe decreases. Typically, payments are first applied to any outstanding fees and interest, and then to the principal. (Pro tip: If you decide to make an extra student loan payment, you should contact your loan servicer and let them know you want the full amount to be applied to your principal balance.)

Why is the date that the loan will be paid off so far in the future?

The term of the loan, which is the length of time you have to repay it, plays a significant role in determining the payoff date. All borrowers with federal student loans are automatically placed on the Standard Repayment Plan, which lasts 10 years.5 However, you also have the option of enrolling in a different repayment plan, such as a graduated repayment plan or income-driven repayment (IDR) plan, which extends the length of the term to make monthly payments more affordable.

Again, longer loan terms spread out the payments over more years, which can make each payment more manageable. But it also means it takes longer to pay off the loan and that means you'll pay more in interest overall.

How much interest will I pay over the life of the loan?

The amount of interest you'll pay over the life of a student loan depends on several factors including the loan amount, the interest rate, the loan term (how long you have to pay it off).

For example, let's say you took out a $20,000 student loan with a fixed rate of 5% and a 10-year repayment period. Your monthly payments would be $212.13, and after the end of those 10 years, you'd pay a total of $5,455.72 in interest.6

Now let's say you kept the 10-year repayment period, but your interest rate was bumped up to 7%. You'd pay $232.22 per month and a total of $7,866.04 in interest.

On the other hand, say the interest rate stayed the same but you extended the payment term to 15 years. In this case, your monthly payments would only be $158.16 — but you'd pay a whopping $8,468.57 in interest over the life of your loan.

What impact does making extra payments on my student loan every month have?

If you're lucky enough to have a lot of extra cash and want to put it toward your student loan, you could potentially pay off your loan much faster and save money in the process.

Let's take our previous example of a $20,000 loan with a 5% rate and 10-year term. If you put another $50 toward your loan each month, you'd pay it off more than two years sooner and shave off $1,356 in interest charges.7

In the end, keep in mind that a college degree is an investment in yourself. Additionally, speaking with a finance specialist may ease anxiety and clarify various scenarios.