Blog Post | July 13, 2007

What a difference the interest rate makes

It is easy for consumers to forget just how expensive a few percentage points of interest really is. I made this point on Tuesday in my presentation at the annual conference of the National Association of Student Financial Aid Administrators. Assume you have $10,000 in loans and the interest is deferred for four years of study, and then the loan is paid in equal installments over ten years:

  • For a subsidized Stafford loan (on which the government covers interest during deferment), the total interest you would pay during that 14-year period would be $3,810.
  • For an “unsubsidized” Stafford loan, the 6.8% interest yields total interest payments of $7,967.
  • If you have a private loan with an interest rate of 10%, you would pay $13,085 in interest on top of that $10,000 borrowed.
  • At 12%, the cost increases by more than $4,000, to $17,091 of interest.
  • At 14%, add another $4,000, to $21,469 of interest.
  • At 18%, you pay a whopping $31,921 of interest on top of the initial $10,000 borrowed, more than four times the interest on an “unsubsidized” Stafford loan.

These numbers, and the differences between them, would of course be even larger if you extend repayment beyond the 10 years used in this example. In an uncertain economy, these examples tell you just how valuable that fixed 6.8% maximum interest rate is on federal student loans (and a maximum of 8.5% on parent loans), whether they carry the “subsidized” moniker or not.

If the numbers alone are not enough to convince, there are many other benefits to federal loans. In a NASFAA session I recently attended, Martha Johnston of Citizens Bank provided a helpful list, including:

  • Federal loans carry automatic full insurance in cases of death or disability. It’s not something parents like to think about, but it happens.
  • Home equity loans (which may carry an interest rate that rivals the federal rate) put your home at risk.
  • Federal loans have unemployment and economic hardship deferments, as well as up to 60 months of forbearance.
  • No prepayment penalties on federal loans, and some ability to extend repayment without a change in the interest rate.
  • The interest rate on federal loans doesn’t go up when rates in the economy increase. (Though it also doesn’t go down if rates were to drop).