August 21, 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. [Read more…]