Understanding Interest Rates, Fees and Interest Capitalization

  • Interest Rates
  • Fees
  • Interest Capitalization

Interest Rates

The interest rate on a loan can be fixed – a rate that stays the same over the life of the loan – or variable – a rate that fluctuates over the life of the loan.

Fixed Interest Rates

The interest rate charged on a fixed rate loan will remain the same for that loan's entire term, regardless of changes to the market interest rates. Attributes of fixed rate loans include:

  • Payment amounts will be the same every month, which allows for a consistent way to manage your budget.
  • If market interest rates go up, your fixed rate will remain the same.

Federal Direct Loans have a fixed interest rate for the life of the loan.

Variable Interest Rates

The interest rate charged on the outstanding balance of a variable rate loan will change periodically. Variable interest rates can change annually, quarterly or even monthly. Attributes of variable rate loans include:

  • Payment amounts may not be the same every month, making it difficult to manage your budget.
  • Your interest rate may be lower or higher depending on market conditions.

Private loans typically have a variable rate, though this is not always the case.


Lenders may charge different fees when you borrow.

Fee Types

The most common types of fees associated with student loans are:

  • Disbursement Fee - charged by the lender and added to the principal amount when the loan is disbursed.
  • Insurance Fee – deducted from each loan disbursement to cover the costs of insuring the loan.
  • Deferment Fee - charged for the benefit of deferring or postponing a loan payment for a period of time.
  • Origination Fee - charged by the lender to offset the cost of processing a loan.
  • Repayment Fee – charged by the lender at the onset of repayment; calculated based on the outstanding loan balance at the time repayment begins.

How Fees Are Paid

Fees can be paid in different ways:

  • Fees may be deducted from the amount you borrow before the loan is disbursed. In this case, you will get less than the amount you originally requested when the loan proceeds are released, or
  • Fees may be borrowed in addition to the approved loan amount. In this case, you will be able to use the total amount you originally requested when the loan proceeds are released but you will have to repay more money because interest accrues on the original amount borrowed (principal) plus any fees.

For example, if the lender assesses a fee of 5 percent and the loan amount is $10,000.00, the fee will be $500. One lender may take this fee from the principal, so you will actually receive $9,500.00. You must, however, pay back $10,000.00 to the lender, plus the interest. Another lender may add the fee to the principal and you will owe $10,500.00, plus interest and fees.

Miscellaneous Fees

Be aware of other charges, such as loan processing fees, or deferment and forbearance fees. Not all lenders assess these fees.

The key to understanding the fees associated with your private student loan is to read the promissory note before you sign it. This is a contract between you and the lender that says the lender will loan you money and you will repay it. Read it carefully, and do not hesitate to discuss it with the lender.

Interest Capitalization

Interest capitalization occurs any time accrued and unpaid interest and loan fees are added to the outstanding principal balance of a loan. The more frequently a lender adds the interest to the principal loan balance, the more interest a borrower will pay.

Depending on the terms of your loan, capitalization may occur throughout repayment or as result of the following:

  • once, prior to repayment;
  • after periods of deferment and/or forbearance;
  • on a regular schedule, such as annually.

More Capitalization = More Expense

The more the loan capitalizes the more expensive the loan will be.

You need to keep this in mind if, for example, you decide to defer making interest payments on an unsubsidized Direct loan or a private loan while you are in school.  The interest that has accrued during the deferment period will be added to the loan principal - capitalized - when the loan goes into repayment.  This will make the total amount owed larger.

The chart below illustrates the difference between paying interest while in school and accruing the interest and having it capitalize once at repayment. The figures are based on a $10,000 loan, 6.8 percent interest rate and 10-year repayment period.

Interest Capitalization Example
Paying Interest while in SchoolCapitalizing Interest - Full Deferment
Total Amount Financed: $10,000.00 Total Amount Financed: $10,000.00
Your Interest Only Monthly Payments: $56.67 Your Interest-Only Payment $0
Your Total Interest During Deferment: $3,343.33 Your Total Capitalized Interest $3,343.33
Your Monthly Payment During Repayment: $115.08 Your Monthly Payments $153.56
Total Cost of Loan: $17,152.97 Total Cost of Loan: $18,426.66

Learn more about the effect of interest capitalization by using the Interest Capitalization Estimator.


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