October 20, 2019

Why is the Starting Balance on my Student Loan More than What I Borrowed?

interest added back into principalYou may be wondering why does my Stafford or Direct student loan statement show a higher principal balance than what I actually borrowed?   The reason your student loan payment seems so high most likely has to do with interest capitalization.

First, you need to understand how a Stafford loan works.  Stafford loans are federal student loans.  As if 2010, the federal government does not guarantee student loans; instead the federal government, through the U.S. Department of Education actually issues student loans.

Subsidized vs. Unsubsidized Student Loans

If you have a Stafford loan, therefore, it was issued prior to 2010 and will be classified as either subsidized or unsubsidized.    Stafford subsidized loans are based on financial need.  Stafford unsubsidized loans are not based on need, and are available to any student borrower.   Post 2010 Direct Loans also may be subsidized or unsubsidized.

If a Stafford or Direct loan is subsidized, this means that interest which accrues while you are in school (the in-school deferment) is paid by the federal government.

If your Stafford or Direct loan is unsubsidized, this means that interest accrues while you are in school.  Once the loan goes into payable status, this accrued interest is “capitalized” into the outstanding principal balance.

Obviously, therefore, you are better off financially with a subsidized Stafford or Direct loan.  Remember, however that subsidized loans are only available to people who have financial need, i.e. meet certain income requirements.  Further, the amount you can obtain as a subsidized loan is limited.

  • Freshmen can receive up to $3,500 per year as a subsidized loan
  • Sophomores can receive up to $4,500 per year as a subsidized loan
  • Juniors can receive up to $4,500 per year as a subsidized loan
  • Seniors  can receive up to $4,500 per year as a subsidized loan

If you do not qualify for a subsidized loan or your tuition exceeds the subsidized limits, you can receive additional Stafford or Direct loans that are unsubsidized:

  • Freshmen can receive up to $2,000 per year as an unsubsidized loan if they are dependents, and $6,000 if they are independent
  • Sophomores can receive up to $2,000 per year as an unsubsidized loan if they are dependents, and $6,000 if they are independent
  • Juniors can receive up to $2,000 per year as an unsubsidized loan if they are dependents, and $7,000 if they are independent
  • Seniors can receive up to $2,000 per year as an unsubsidized loan if they are dependents, and $7,000 if they are independent

What does it mean that the accrued interest is capitalized?

Above, I noted that interest on unsubsidized loans accrues while you are in school (the in-school deferment).  Once you get out of school, you have a 6 month grace period before payments come due.

Once payments come due, the accrued interest is added to the outstanding principal and interest begins accruing on this new (higher) principal.

Here’s an example.  Let’s assume you borrowed $10,000 of unsubsidized loans at a 3.9% interest rate.  The loan goes into payable status 6 months after you graduate.

During the 4 years while you were in school plus the 6 month grace period (54 months), your loan would accrue $1,755 in interest.  Thus, your first loan statement will show an outstanding balance of $11, 755, rather than $10,000.

Interest on the $11,775 principal over the standard 10 year repayment will amount to another $704.70, meaning that your total interest cost on this loan will be $2,459.70, and your monthly payment will be $118.46 for 10 years.

How to Avoid Capitalization Penalties

If possible, therefore, it would be wise to send in the interest payments each month while you are in school or the loan is otherwise in deferment.

Another way to avoid the capitalization penalty would be to enter into an income based repayment plan (IBR).  This will reduce your payment down to a figure that fits your budget although it may extend the term of your loan.  Interestingly, if your income is low, your IBR payment may be zero or some small number, but even zero payments count towards the term of the repayment.

As a student loan lawyer, we can look at all of the repayment plan options to figure out what makes sense for you both in the long term and in the short term. Call us for a no obligation loan portfolio review.

Jonathan Ginsberg

Attorney at Law at Ginsberg Law Offices
Jonathan Ginsberg has served the Atlanta area community as a personal bankruptcy and student loan debt management lawyer for over 25 years. Contact Jonathan for straight answers to difficult debt problems.
Jonathan Ginsberg
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Jonathan Ginsberg

Jonathan Ginsberg has served the Atlanta area community as a personal bankruptcy and student loan debt management lawyer for over 25 years. Contact Jonathan for straight answers to difficult debt problems.

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