How student loan interest works

How is student loan interest calculated?

Federal Direct Loans use daily simple interest. Simple interest means interest is charged only on your principal, not on interest that has already piled up (until it capitalizes, more on that below). "Daily" means it is recalculated every single day.

Federal Student Aid gives the formula in two steps. First, find your interest rate factor:

Interest rate factor = interest rate / number of days in the year

Then multiply that by your balance and the number of days:

Daily interest = (outstanding principal balance × interest rate factor) × number of days since your last payment

A simpler way to write the whole thing out:

Interest = balance × annual rate / 365 × days

A worked example

Say you owe $10,000 on an undergraduate Direct Unsubsidized Loan at the current 6.39% rate.

• Interest rate factor: 0.0639 / 365 = 0.000175 per day
• One day of interest: $10,000 × 0.000175 = $1.75 per day
• A 30-day month: $1.75 × 30 = about $52.50
• A full year, unpaid: $10,000 × 0.0639 = about $639

Because it is simple interest, that daily charge stays at $1.75 as long as your balance stays $10,000. It only climbs when the balance climbs, which is exactly what capitalization does.

When does interest start?

It depends on whether your loan is subsidized or unsubsidized, and this is the most important distinction in federal lending. Our guide to subsidized vs unsubsidized loans covers it in full.

• Direct Subsidized Loans (undergraduates with financial need): the U.S. Department of Education pays your interest while you are enrolled at least half-time, during your six-month grace period, and during approved deferment. You are not charged interest during those windows.
• Direct Unsubsidized Loans (undergraduate and graduate students, no need test): interest starts accruing the day the money is disbursed to your school, and every dollar of it is yours. It never stops, in school or out.

So on an unsubsidized loan, interest is quietly building the entire time you are studying, even though you are not required to make payments yet.

What is capitalization?

Capitalization is when your unpaid accrued interest gets added to your principal balance. Your loan then calculates future interest on that new, larger balance. That is the "interest on interest" trap: it permanently raises the base your daily interest is charged on.

Capitalization typically happens at specific trigger points:

• At the end of your grace period, when your loan enters repayment
• At the end of a deferment (on unsubsidized loans)
• At the end of a forbearance
• When you leave certain income-driven repayment plans or fail to recertify

Example of the damage: if $2,000 of interest accrued while you were in school and it capitalizes onto a $10,000 loan, your new balance is $12,000. Your daily interest rate factor has not changed, but it now applies to $12,000 instead of $10,000, so your $1.75-a-day charge becomes about $2.10 a day, for the entire remaining life of the loan.

How do I pay less interest?

You have real control here. The levers, in rough order of impact:

1. Pay the interest on unsubsidized loans while you are still in school. The amounts are small (often $30 to $60 a month per $10,000 borrowed), and paying it keeps it from capitalizing later. This is the single biggest avoidable cost.
2. Take subsidized loans first. They carry the same rate as undergraduate unsubsidized loans (6.39% for 2025-26) but the government eats the interest during school, grace, and deferment. Always borrow every subsidized dollar you qualify for before touching unsubsidized money.
3. Avoid or shorten deferment and forbearance when you can. Interest keeps accruing during both, and it capitalizes at the end. If you must pause payments, pay at least the interest so nothing capitalizes.
4. Pay extra toward principal. Because interest is charged only on principal, every dollar you knock off the balance lowers every future day's interest. Tell your servicer to apply extra payments to principal, not to future payments.
5. Pay on time and set up autopay. Federal servicers give a 0.25 percentage point interest rate reduction for automatic payments, and paying more often means fewer days of accrual between payments.

The 2025-26 federal Direct Loan rates

For loans first disbursed between July 1, 2025 and June 30, 2026, the fixed rates are:

Source: Federal Student Aid, interest rates for Direct Loans first disbursed July 1, 2025 through June 30, 2026.

These are fixed for the life of each loan, so a loan you take out this year keeps its rate even after new rates are set next July.