Daily Simple Interest: The Standard Method
Most federal and private student loans accrue interest daily using a simple interest formula:
Daily Interest = (Outstanding Principal × Annual Interest Rate) ÷ 365
This daily amount accumulates and is what makes up the interest portion of your eventual monthly payments.
Subsidized vs. Unsubsidized: When Interest Starts
- Subsidized federal loans: The government pays the interest while you're in school at least half-time, during your grace period, and during certain deferment periods — interest doesn't accrue to your balance during these times.
- Unsubsidized federal loans and most private loans: Interest begins accruing from the day the loan is disbursed, even while you're still in school, though you're typically not required to make payments until after your grace period.
Capitalization: Where Balances Can Grow Faster Than Expected
Capitalization happens when unpaid accrued interest is added to your principal balance — after this happens, you start accruing interest on the new, larger principal (interest on interest). This commonly occurs at the end of a grace period, after a deferment or forbearance ends, or when you switch repayment plans in some cases.
This is why an unsubsidized loan balance can be noticeably higher at the start of repayment than the original amount borrowed — the accrued interest during school and the grace period gets capitalized into a new, larger principal.
A Concrete Example
Say you borrow $10,000 in unsubsidized loans as a freshman, at 6% interest, and don't make any payments for four years of school plus a 6-month grace period (4.5 years total):
- Interest accrued over 4.5 years: roughly $2,700
- If this capitalizes at the start of repayment, your new principal becomes approximately $12,700
- You now pay interest on $12,700, not the original $10,000 — a real, permanent increase in your total borrowing cost
Why Paying Interest While in School (If You Can) Helps
Even small voluntary payments toward accruing interest while still in school prevent that interest from capitalizing later, keeping your principal balance lower when repayment begins. This isn't always financially feasible for students, but it's a genuinely effective strategy for those who can manage it.
Understanding Your Amortization Once in Repayment
Once in standard repayment, each payment covers that period's accrued interest first, with the remainder reducing principal — identical in structure to how mortgage or auto loan amortization works. Use a Student Loan Calculator to see your specific payment breakdown and total interest over the life of the loan.