Calculating Monthly Student Loan Payments

Instructor: Tiffany Price

Tiffany has many years of classroom teaching experience and has a masters degree in Educational Leadership.

In this lesson, we will discuss how student loans work and how they are calculated. We will also talk about the plans you should make to save money by paying your loan back sooner than what the payment schedule says.

So, you're in college and can't cover school and living expenses. No worries! You are in good company. Millions of dollars from the government and private entities pay out for students to go to college. So, whether you've already made the leap and have taken out a loan, or you're still crunching numbers and thinking about taking out a loan, this lesson may be of use to you.

There are several types of loans available to you, depending on your income, what year of school you're in, what you are studying, what the funds will pay for, etc. The most desired loan with the best terms is the Perkins loan. The interest rate is the lowest, and interest is subsidized by the government while you are in school. Subsidized means the government is paying the interest for you until you get out of school. The Perkins loan is reserved for students with the greatest financial need. Stafford loans are the most common loan received. With the Stafford loan, interest can also be subsidized, if you are eligible. Otherwise, you will be responsible for paying the interest that accrues while you are in school. Accrued interest is money that accumulates over time. PLUS loans are available for parents and graduate students only, and the funds can be used on any needs the student may have while in school. Undergraduates do not qualify for PLUS loans. Lastly, private education loans are issued by private lenders (the banks themselves) and are similar to personal loans. Both students and parents can apply for private loans.

Upon getting a loan, you must sign a promissory note that describes the terms of the loan that you are about to get. There is very important information on this document, such as the issue date, amount borrowed, interest rate, monthly or daily interest, and payment schedule.

  • Issue Date - The day interest starts to accrue
  • Amount Borrowed - The total amount of the loan, also called the Principal amount
  • Interest rate - The fee for borrowing
  • Daily/Monthly Interest - States whether your interest accrues daily or monthly
  • Payment info - The date you must start repaying and how many payments you have

School loan interest is usually compounded daily, meaning the yearly interest rate is divided by 365. For instance, if you take out a loan for $8500 with an interest rate 5% (which is the fixed rate for the Perkins loan), the daily interest amount being accrued is 0.014%, which is about $1.19. This means you will be paying about $36 in interest that month.

Now, there is a useful thing to keep in mind when calculating your payments: even though your payment is the same every month, the money is allotted toward two different 'pots.' The pots are the interest and the principal. In the beginning, most of your payment is going toward the interest, and very little is going toward the principal. In other words, the bank pays itself first. Because your payment won't chip away at the actual loan amount much in the beginning, the bank can calculate interest on that larger principal amount. The charts below further illustrate how your payments are allocated.

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