4 Facts You Should Know About Student Loan Interest

Source: Thinkstock
Source: Thinkstock

Content provided by Student Loan Hero

Student loan debt is becoming one of the most pressing issues for Americans today – and with good reason. Student debt at graduation has increased at double the rate of inflation, according to a recent report, with the class of 2014 graduates owing nearly $30,000 on average.

Although the skyrocketing cost of education is largely to blame, another factor can majorly add to the size of your debt over time: student loan interest.

If anyone understands the serious impact of interest on student loans, it’s me. I graduated in 2009 with over $74,000 in student debt. Due to financial constraints, I chose to defer my loan payments – little did I know that would cause my debt to balloon to over $100,000 within months thanks to the interest charges I accrued.

If left unchecked, student loan interest can cause your existing debt to skyrocket. So whether you’re a current student or have already graduated, here are three things to keep in mind about interest as you get ready to start making payments.

1. Interest Can Accrue Even When You Aren’t Making Payments

It’s important to understand how and when interest is charged, especially if you choose to enroll in an income-based repayment plan, defer payments, or enter forbearance. In many cases, loan interest will continue to accumulate even if you aren’t required to make full payments toward the principal balance.

For example, the government won’t cover interest payments on unsubsidized loans or PLUS loans in deferment. Interested accrued on any loan during forbearance is also not covered. That means if you don’t make these interest payments yourself, they will be tacked onto your loan balance every month. The worst part? You’ll start paying interest on your interest!

2. Consolidation Doesn’t Always Save Money on Interest

When choosing a repayment strategy, it’s always important to do the math and make sure you’re saving as much money as you can. Student loan consolidation is often recommended as a tool for cutting the cost of student debt, but it doesn’t always do so.

Some borrowers, for instance, opt for the “debt avalanche” method of paying down student loan debt, which tackles the highest interest loans first. This is a great plan for avoiding excess interest charges. However, if you choose to consolidate your loans, you lose the option of prioritizing payments by interest rate – instead, you get one new loan with one interest rate. Although convenient and helpful for lowering monthly payments, Direct Consolidation Loans can result in paying extra interest over time.

3. You Can Take Advantage of Tax Breaks on Interest

Don’t assume you have to itemize your taxes in order to enjoy some pretty helpful tax breaks. While write-offs like charitable donations or moving expenses require itemizing instead of taking the standard deduction, student loan interest is an “above-the-line” deduction you can use to adjust your taxable income.

Borrowers can deduct up to $2,500 per year. In fact, it’s possible to claim this deduction even if your parents are the ones making payments, as long as you’re not considered a dependent. It’s important to note, however, that the amount you can claim will reduce over time and eventually phase out as your modified adjusted gross income reaches the annual limit.

4. Interest Rates Make a Big Difference

In my experience, one of the best ways to reduce the amount of interest you pay on student loans is by refinancing to a lower interest rate.

Refinancing is when you get a new loan with a new rate and terms to replace your existing loan(s). If you’re paying higher interest rates than average (federal Direct PLUS loans average 6.84% right now, for example) and have good credit, refinancing might be your best bet. Use a loan refinancing calculator to quickly see how much money you might save with a lower rate.

Again, the strategy you use to pay off student loan debt is a personal choice based on your own unique financial situation. But one thing is true for anyone with student loans: interest is your enemy. Whatever plan you choose, make cutting interest charges a top priority so you can live a debt-free life as soon as possible.

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