Interest rates for federal student loans dropped to all-time lows for the 2020-2021 school year. Borrowing from the federal government to cover educational costs is now cheaper than ever before.
Let’s take a look at the 2021 federal student loan interest rates, how interest rates for federal student loans work, and a few student loan interest rate FAQs.
2021 Federal Student Loan Interest Rates
|Borrower Type||Loan Type||Interest Rate|
|Undergraduate||Direct Subsidized Loans||2.75%|
|Undergraduate||Direct Unsubsidized Loans||2.75%|
|Graduate or Professional||Direct Unsubsidized Loans||4.30%|
|Graduate or Professional||Direct Grad PLUS Loans||5.30%|
|Parents||Direct Parent PLUS Loans||5.30%|
Data from Federal Student Aid
Who Sets Interest Rates for Federal Student Loans?
Congress sets the interest rates for federal student loans. Rates are based on the 10-year Treasury notes, plus a fixed increase. Each spring, Congress passes the interest rates for the upcoming school year into law.
How is Interest Calculated for Federal Student Loans?
A daily interest formula determines how much interest accrues on your federal student loans between each monthly payment.
The simple daily interest formula looks like this:
Outstanding Principal Balance x Interest Rate Factor = Daily Interest Amount
- Outstanding principal balance: The remaining amount of principal left on your loan
- Interest rate factor: Your loan’s interest rate divided by the number of days in the year
Sample Daily Interest Rate Calculation
Xavier has an outstanding principal balance of $11,500 for his Direct Grad Plus loan with a 5.30% interest rate.
Interest rate factor = .053 / 366 = 0.000145 or 0.0145%
Daily interest: $11,500 x 0.000145 = $1.67
Each day, Xavier’s loan balance grows by $1.67. When Xavier makes his monthly student loan payment, it covers the portion of the principal he owes, as well as the $1.67 per day interest that accrued since his last payment.
What is Interest Capitalization?
According to Federal Student Aid, capitalization is “the addition of unpaid interest to the principal balance of a loan.” Capitalization is another cost of borrowing federal student loans.
Interest on your federal student loans only capitalizes when your monthly payment doesn’t cover your unpaid interest.
During periods when you’re not making monthly payments—like deferment while you’re a student—interest accumulates, but you’re not paying it off. As soon as your loan enters repayment, all of that accrued interest gets added to your outstanding loan balance. In other words, that interest starts growing interest.
Situations where unpaid interest capitalizes include:
- After periods of deferment on unsubsidized loans
- After periods of forbearance on all types of loans
- After the grace period on an unsubsidized loan
- If you leave the Revised Pay as You Earn (REPAYE), Pay as You Earn (PAYE), or Income-Based Repayment (IBR) plans
- If you do not recertify your income for the REPAYE, PAYE, and IBR plans
- If you are in PAYE or IBR but no longer qualify to make student loan payments based on income
- If you’re on the Income-Contingent Repayment (ICR) plan, then interest capitalizes annually
- When you consolidate federal loans
Do Federal Student Loans Have Other Fees?
Along with an interest rate, federal student loans also have loan fees. A loan fee is a fixed percentage of the total loan amount. It’s deducted from your loan disbursements. What that means is this: you’re receiving less money to put toward your education than you’re actually borrowing.
2021 Federal Student Loan Fees
|Loan Type||First Disbursed||Loan Fee|
|Direct Subsidized & Direct Unsubsidized Loans||October 1, 2019 to September 30, 2020||1.059%|
|October 1, 2020 to September 30, 2021||1.057%|
|Direct PLUS Loans||October 1, 2019 to September 30, 2020||4.236%|
|October 1, 2020 to September 30, 2021||4.228%|
Data from Federal Student Aid
What is the Average Private Student Loan Interest Rate in 2021?
Unlike federal student loan interest rates, private student loan interest rates are competitive. The rate you’re offered does correlate to the market rates, but it’s also dependent on your credit score, income, and credit history. Borrowers with a stable income and a credit score of at least 750 typically qualify for the lowest rates.
Private student loan interest rates for the 2021 academic year are crazy low. In September 2020, the Federal Reserve announced it would keep the federal funds rate at 0 to 0.25 percent until labor market conditions improve. Student loan companies set their rates based on the federal funds rates. This is excellent news for borrowers.
Here’s a look at the interest rate ranges offered by the best private student loan lenders that we partner with:
Federal Student Loan Interest Rate FAQs
Are federal student loan interest rates fixed?
Yes, all federal student loan interest rates are fixed. The rates remain the same throughout the life of the loan. Private student loans can have a variable or a fixed interest rate.
Can you negotiate federal student loan interest rates?
No, all federal student loan interest rates are set by Congress. Each loan type is assigned a fixed interest rate based on its disbursement date and borrower.
How can I avoid paying interest on student loans?
The only way to completely avoid paying interest on your student loans would be to pay off the balance in full immediately upon disbursement. Of course, if you could do that, you likely wouldn’t need to borrow student loans in the first place.
You can, however, avoid capitalized interest on your federal student loans by doing the following:
- Making at least interest-only payments on unsubsidized student loans while you’re enrolled
- Making at least interest-only payments on unsubsidized student loans during your grace period
- Avoiding deferment or forbearance
- Paying off all interest before you unenroll from or no longer qualify for an income-based repayment plan
Is there a tax benefit for paying off student loan interest?
Yes, many student loan borrowers and their parents can claim the student loan interest deduction. It’s a federal income tax deduction that lets you deduct up to $2,500 in interest paid on qualifying federal or private student loans.
Only borrowers who meet certain income requirements qualify for the deduction. You do not need to itemize deductions on Schedule A to claim this deduction. If you paid more than $600 in interest from a single lender, you should receive an electronic or paper Form 1098-E. If you paid less than $600, you would need to self-report the amount of interest you paid.
Since federal student loan interest rates have been set to 0% since March 13, 2020, it’s unlikely that you will have much federal student loan interest to deduct for the tax year 2020.