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Consider an Interest-Only Plan to Save on Student Loans

Ben LuthiPublished on

interest only plan

College students aren’t required to make payments while they’re in school. Whether you have federal or private student loans, your payments will typically start six months after you graduate or fall below half-time status.

But if you have unsubsidized federal student loans, PLUS loans, or private student loans, interest is accruing on your balance even though there are no payments due. Paying that interest as it builds each month is one of the best things you can do for your future.

The difference between deferred and interest-only payment options

When you apply for private student loans, you may notice more than one way to repay your loan. Common options include immediate, deferred and interest-only payments.

With immediate payments, you’ll start repaying the debt immediately. This may be a good option if you’re the parent of a student and can afford it, but if you’re a student with no job or limited income, it’s likely not doable.

With deferred payments, you don’t have to make any payments at all until after you leave school, often with a grace period of six months. If you have federal student loans, this is the default payment option.

With interest-only payments, however, you’ll pay interest each month while you’re in school, then switch to regular payments after you graduate or are no longer in school for another reason.

So, if you’re wondering, “Can you pay student loans while in school?” the answer is not only yes, but “please do.” While the deferred repayment option may sound more appealing, opting for interest-only payments could save you thousands of dollars and make your future student loan payments much more affordable.

How interest-only loans work

Interest-only loans allow you to eliminate the effect of capitalized interest on your student loans while you’re attending school. Capitalization occurs when the interest that’s accrued while you’re in school gets added to your principal balance.

If you borrow $10,000 with a deferred repayment schedule, for instance, your balance when you graduate won’t be $10,000. Instead, it’ll be the original amount plus any interest that has been added to the loan over the years.

As a result, your monthly payment will be higher, and you’ll ultimately pay more interest over the life of the loan.

As an example, let’s say $3,000 of interest has accrued while you’re in school. If the interest rate on the loan is 6% and you’re on a 10-year repayment plan, your $13,000 loan will have a monthly payment of $144, and you’ll pay $17,319 total for the $10,000 loan.

If, however, you pay the $3,000 in interest while still in school, you’ll still have a $10,000 balance when you graduate. Your monthly payment will be $111, and you’ll pay $16,322 total, including the interest-only payments.

So in total, you’ll save close to $1,000 by making interest-only payments while you’re in school. And if you borrow more than $10,000, the potential savings increase.

How to pay interest on student loans while in school

Interest-only loans can save you money in the long run, so it’s worth trying to make those payments while in school if you can afford it.

If you’re borrowing money from a private lender, you may have the option to set up an interest-only repayment plan from the start. In fact, some lenders offer a lower interest rate for interest only student loans than on deferred student loans.  Not all lenders offer this setup, however, so you may need to contact yours to arrange interest payments after your loan has been disbursed.

If you have federal student loans, the default setting is deferred repayment. To set up interest-only payments, call your loan servicer, who can help you find out how much interest accrues each month and how to pay it off monthly, so it doesn’t capitalize when you leave school.

Tips for paying interest on student loans while in school

While making interest payments while you’re in school can help you save money in the long run, it may not be easy if you’re a full-time student. Here are some things to consider.

Get a part-time job

Working during school may not sound ideal, especially while you’re trying to juggle coursework and a social life, but it can give you the funds you need to pay your accrued interest each month. Even if you just work a handful of hours a week, it may be enough to cover the small monthly payment.

Work during the summer

If you’d rather not get a job while classes are in session, an alternative is to get a full-time job when they aren’t. By working during the summer and saving much of what you earn, you can make your monthly interest payments without having to add more stress during the school year.

Ask for help

If your parents are willing to help you with education costs, paying your accrued interest could make a big impact for you in the long run.

Create a budget

Chances are that you not only borrowed money to pay for tuition and books, but also for some of your living expenses. By creating a monthly budget, you can have a better idea of how you spend that money and make room for interest payments by cutting back on some of your discretionary spending.

Learning to budget while you’re in college will not only help you find money to make interest-only payments, but it can also set you up for financial success in the future.

Reduce your interest payments by shopping around

Learning how to pay interest on student loans while in school is important to saving money while you’re in repayment. And you can maximize those savings by comparing lenders to make sure you get the lowest interest rate possible.

If you’re an undergraduate student, chances are that you’ll get the lowest interest rate from federal loans through the U.S. Department of Education. If, however, you’re a graduate student or a parent, you may be able to score a lower interest rate through a private lender.

That said, private lenders base their terms on your creditworthiness, so it’s important to shop around and compare rates. You can do this easily using the Purefy rate comparison tool.

Just share some information about your schooling situation, where you live, and your email address, and you can view rate offers from several lenders in the same place.

The bottom line

Interest-only loans require a little extra work while you’re in school, but they can help you reduce monthly payments after you graduate and save you money over the life of your loans. If you can find a way to afford interest payments, make it a goal to do so.