Monday, January 14, 2013

Paying Interest While in School

Often, a student will ask "Should I pay interest on my student loans while I'm in school?" And without hesitation, I always say "If you can afford it, you definitely should at least pay the interest." Why? First you have to look at where the interest is building.

The Subsidized and Unsubsidized loans are similar in many aspects, but the biggest difference is the way interest accrues while you're in school. The interest on the Subsidized loan is subsidized by the government during your enrollment (hence the name of the loan). The Unsubsidized loan is not subsidized by the government, so as soon as your loan is disbursed, interest will begin accruing on it. These loans usually have a 6-month grace period before you are required to make payments; however, interest will be accruing on both the Subsidized loan and the Unsubsidized loan during this time. Once you graduate, your Subsidized loan will begin accruing interest.

Next, let's look at a specific example. Let's say you are enrolled for a 12-month period of time while payments are not required, and you have a total of $15,000 of Unsubsidized loans. This means your interest rate will be 6.8%. If you pay your interest along the way, then you will pay a total of $1,020 in interest for that 12 months. When you finish your 12-month period, then you will owe just $15,000. Sound like a lot? Compare to if you pay nothing. That same $1,020 will be added to your existing $15,000, so you will owe $16,020 when you finish. You may say that you're still paying the same amount so it doesn't matter. Where it does matter is in repayment. There's a big difference in going into repayment owing only $15,000 as compared to $16,020. How big?

You have 10 years to pay off these student loans, which comes out to 120 monthly payments. If you'd been paying your interest, then your monthly payment on a standard repayment plan would be $173; whereas, if you hadn't been paying, then your monthly payment will be $184. Also, the total amount repaid over the entire repayment period (without anything changing such as payment plan or deferments/forbearances/delinquencies) if you've been repaying your interest would be a total of $21,734. But if you hadn't been paying your interest, then that total would be $22,123.

So in this example, you could be saving $11 a month, or $389 over the life of the loan. There are other benefits to paying interest while in school such as becoming familiar with the process early and becoming comfortable with it. Another great thing is it will help to give you good habits.

Don't forget: pre-payment on your loan itself is allowed also. You don't have to stay at just paying the interest; the more you pay early, the more you'll save in the end!

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