Understanding the accrual of interest is an important component of understanding student loans and college debt. Like a home mortgage, borrowed money paid back over long periods of time can become exponentially more expensive depending on the rate of interest charged and how the interest is added to the principal of the money borrowed.
What is Interest?
Interest is the cost of borrowing money paid to the lender. Interest is calculated as a percentage of the unpaid amount borrowed (called “principal”). Unlike other forms of debt, such as credit cards and mortgages, Federal Direct Student Loans accrue interest on a daily basis rather than monthly.
What are the Interest Rates on Federal Student Loans?
The interest rate charged on federal student loans varies depending on the type of loan type and the first disbursement date of the loan. The table below provides interest rates for Direct Subsidized Loans, Direct Unsubsidized Loans, and Direct PLUS Loans first disbursed on or after July 1, 2019, and before July 1, 2020.
| TYPE OF LOAN | BORROWER STATUS | FIXED RATE OF INTEREST |
| Direct Subsidized Loans and Direct Unsubsidized Loans | Undergraduate | 4.53% |
| Direct Unsubsidized Loans | Graduate or Professional | 6.08% |
| Direct PLUS Loans | Parents and Graduate or Professional Students | 7.08% |
Perkins Loans (regardless of the first disbursement date) have a fixed interest rate of 5%.
Capitalization of Federal Direct Student Loan Interest
Capitalization is the addition of unpaid interest to the principal balance of a loan.
When interest on federal student loans is not paid as it accrues during periods when the borrower is responsible for paying interest, the lender may capitalize the unpaid interest. This increases the outstanding principal amount due on the loan – paying interest on interest. Interest is then charged on that higher principal balance, increasing the overall cost of the loan. Depending on the borrower’s repayment plan, capitalization may cause the monthly payment amount to increase.
During Federal Student Loan repayment periods, monthly loan payments cover all of the interest that accrues between monthly payments leaving no unpaid interest. However, unpaid interest will accrue under a variety of circumstances including:
- Unsubsidized loan deferment periods,
- Forbearance periods on any all types of Federal student loans,
- Repayment under an income-driven repayment plan where the required monthly loan payment is less than the amount of interest that accrues between payments,
- When the borrower defaults or voluntarily leaves the Revised Pay as You Earn, Pay as You Earn (PAYE) or Income-Based Repayment (IBR) plans,
- When the borrower fails to annually update his/her income for some of the income-driven plans, or
- When the borrower is repaying under PAYE or IBR plans and no longer qualifies to make payments based on income.
Interest is never capitalized on Federal Perkins Loans.