Introduction
If you’ve taken out federal student loans, repaying your entire loan balance plus interest is a requirement, unless you qualify for forgiveness.
Interest is the ‘cost’ attached to borrowing student loans.
While there are several opportunities for physicians to reduce their student loan payments or increase the amount forgiven, there’s a persistent factor called interest that looms in the background.
Let’s understand the mechanics of how student loan interest is calculated and review the distinction between interest accrual and interest capitalization.
Introduction
If you’ve taken out federal student loans, repaying your entire loan balance plus interest is a requirement, unless you qualify for forgiveness.
Interest is the ‘cost’ attached to borrowing student loans.
While there are several opportunities for physicians to reduce their student loan payments or increase the amount forgiven, there’s a persistent factor called interest that looms in the background.
Let’s understand the mechanics of how student loan interest is calculated and review the distinction between interest accrual and interest capitalization.
If you’ve taken out federal student loans, repaying your entire loan balance plus interest is a requirement, unless you qualify for forgiveness.
Interest is the ‘cost’ attached to borrowing student loans.
While there are several opportunities for physicians to reduce their student loan payments or increase the amount forgiven, there’s a persistent factor called interest that looms in the background.
Let’s understand the mechanics of how student loan interest is calculated and review the distinction between interest accrual and interest capitalization.
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Subscribe to The Dream Bigger – Physician Edition Newsetter
A weekly newsletter designed for early-career physicians and anyone looking to enhance their financial well-being.
Discover helpful tips, strategies, and insights to dream bigger and take control of your financial future. 🥼
Get student loan updates, money-saving tips, and financial strategies – all delivered to your inbox.
Imagine your federal student loan payment as two buckets.
☁️ Bucket 1 holds your student loan balance and remains constant throughout your time in school.
☁️ Bucket 2 starts empty, serving as the space where your interest payments accumulate each year while you’re in school.
While you’re in school, each day that passes without a payment covering your interest adds to the amount you owe on your student loans. In other words, the outstanding balance grows for every day you don’t make a payment that covers the accruing interest.
The interest owed is calculated through a simple daily interest payment, based on the value in Bucket 1, not the interest in Bucket 2.
Federal student loans operate with simple interest, meaning you only pay interest on the original amount you borrowed. There’s no compounding or capitalization; instead, all the accrued interest just stacks up in Bucket 2. Each day, the interest is computed based on the unchanged value in Bucket 1.
If you find yourself not making interest payments while in school, you’re not alone. However, it’s important to grasp how interest is calculated.
Simple Daily Interest Formula:
☁️ Interest Amount = (Outstanding Principal Balance x Interest Rate Factor) x Number of Days Since Last Payment
☁️ Interest Rate Factor = Interest Rate ÷ # of Days in the Year
Unpaid interest accrues whenever you’re paying less interest on your student loans than you would under the Standard Repayment Plan. This happens, for example:
☁️ During School and Grace Periods for Unsubsidized Loans
☁️ During Deferment for Unsubsidized Loans
☁️ During Forbearance
☁️ On Income-Driven Repayment (IDR) Plans
☁️ Direct Subsidized Loans: You are not required to pay the interest that accrues while you are in school or during the first six months after you graduate.
☁️ Direct Unsubsidized Loans: You are required to pay the interest that accrues while you are in school.
Imagine your federal student loan payment as two buckets.
☁️ Bucket 1 holds your student loan balance and remains constant throughout your time in school.
☁️ Bucket 2 starts empty, serving as the space where your interest payments accumulate each year while you’re in school.
While you’re in school, each day that passes without a payment covering your interest adds to the amount you owe on your student loans. In other words, the outstanding balance grows for every day you don’t make a payment that covers the accruing interest.
The interest owed is calculated through a simple daily interest payment, based on the value in Bucket 1, not the interest in Bucket 2.
Federal student loans operate with simple interest, meaning you only pay interest on the original amount you borrowed. There’s no compounding or capitalization; instead, all the accrued interest just stacks up in Bucket 2. Each day, the interest is computed based on the unchanged value in Bucket 1.
If you find yourself not making interest payments while in school, you’re not alone. However, it’s important to grasp how interest is calculated.
Simple Daily Interest Formula:
☁️ Interest Amount = (Outstanding Principal Balance x Interest Rate Factor) x Number of Days Since Last Payment
☁️ Interest Rate Factor = Interest Rate ÷ # of Days in the Year
Unpaid interest accrues whenever you’re paying less interest on your student loans than you would under the Standard Repayment Plan. This happens, for example:
☁️ During School and Grace Periods for Unsubsidized Loans
☁️ During Deferment for Unsubsidized Loans
☁️ During Forbearance
☁️ On Income-Driven Repayment (IDR) Plans
☁️ Direct Subsidized Loans: You are not required to pay the interest that accrues while you are in school or during the first six months after you graduate.
☁️ Direct Unsubsidized Loans: You are required to pay the interest that accrues while you are in school.
In your first year of med school, you borrow $100,000 at a 10% interest rate, assume it covers all four years for simplicity.
☁️ Bucket 1 starts with $100,000
☁️ Bucket 2 is empty
Daily interest is calculated based on the value in Bucket 1, and instead of being added to Bucket 1, it accrues in Bucket 2 day after day.
To illustrate this:
1st Day of MS1:
☁️ Bucket 1: $100,000
☁️ Bucket 2: $27.40 ($100,000 x 0.1) ÷ 365
2nd Day of MS1:
☁️ Bucket 1: $100,000
☁️ Bucket 2: $54.80 ($27.40 x 2)
…
365th Day (1 year later):
☁️ Bucket 1: $100,000
☁️ Bucket 2: $10,000 ($27.40 x 365)
…
730th Day (2 years later):
☁️ Bucket 1: $100,000
☁️ Bucket 2: $20,000 ($27.40 x 730)
…
1643rd Day (4 years of med school + 6-month grace period):
☁️ Bucket 1: $100,000
☁️ Bucket 2: $45,000
(Note: The calculation is a little more complicated than this illustration.)
In your first year of med school, you borrow $100,000 at a 10% interest rate, assume it covers all four years for simplicity.
☁️ Bucket 1 starts with $100,000
☁️ Bucket 2 is empty
Daily interest is calculated based on the value in Bucket 1, and instead of being added to Bucket 1, it accrues in Bucket 2 day after day.
To illustrate this:
1st Day of MS1:
☁️ Bucket 1: $100,000
☁️ Bucket 2: $27.40 ($100,000 x 0.1) ÷ 365
2nd Day of MS1:
☁️ Bucket 1: $100,000
☁️ Bucket 2: $54.80 ($27.40 x 2)
…
365th Day (1 year later):
☁️ Bucket 1: $100,000
☁️ Bucket 2: $10,000 ($27.40 x 365)
…
730th Day (2 years later):
☁️ Bucket 1: $100,000
☁️ Bucket 2: $20,000 ($27.40 x 730)
…
1643rd Day (4 years of med school + 6-month grace period):
☁️ Bucket 1: $100,000
☁️ Bucket 2: $45,000
(Note: The calculation is a little more complicated than this illustration.)
Understanding Student Loan Interest Capitalization
Federal student loans ‘capitalize’ (Bucket 2, representing accrued interest, merges with Bucket 1, the principal) triggered by specific events:
☁️ Repayment begins
☁️ Deferment ends
☁️ Forbearance ends
☁️ Upon default
☁️ Change in repayment plan
☁️ Loan consolidation
☁️ You fail to recertify your income for an IDR plan by the anniversary date.
Once capitalization occurs, any unpaid interest accumulated in Bucket 2 combines with Bucket 1. From that point onward, you begin paying interest on the new total in Bucket 1, comprising the initial loan balance plus the accumulated interest over the years.
Note: Consolidating your federal student loans immediately after graduating from med school triggers interest capitalization. If you delay or do not consolidate your loans, capitalization will occur after your 6-month grace period.
Understanding Student Loan Interest Capitalization
Federal student loans ‘capitalize’ (Bucket 2, representing accrued interest, merges with Bucket 1, the principal) triggered by specific events:
☁️ Repayment begins
☁️ Deferment ends
☁️ Forbearance ends
☁️ Upon default
☁️ Change in repayment plan
☁️ Loan consolidation
☁️ You fail to recertify your income for an IDR plan by the anniversary date.
Once capitalization occurs, any unpaid interest accumulated in Bucket 2 combines with Bucket 1. From that point onward, you begin paying interest on the new total in Bucket 1, comprising the initial loan balance plus the accumulated interest over the years.
Note: Consolidating your federal student loans immediately after graduating from med school triggers interest capitalization. If you delay or do not consolidate your loans, capitalization will occur after your 6-month grace period.
Continuing our example, after completing med school, your loans entered the “In Grace Period” status. During this 6-month phase, no payments were required on your student loans.
Here’s the snapshot at the end of the 6-month grace period (1643rd Day – 4 years of med school + 6-month grace period):
☁️ Bucket 1: $100,000
☁️ Bucket 2: $45,000
Following this grace period, your loans transitioned into “In Repayment” status, triggering interest capitalization.
☁️ Bucket 1: $145,000
☁️ Bucket 2: $0
From this point onward, your interest calculation will be based on the new capitalized student loan balance of $145,000.
Continuing our example, after completing med school, your loans entered the “In Grace Period” status. During this 6-month phase, no payments were required on your student loans.
Here’s the snapshot at the end of the 6-month grace period (1643rd Day – 4 years of med school + 6-month grace period):
☁️ Bucket 1: $100,000
☁️ Bucket 2: $45,000
Following this grace period, your loans transitioned into “In Repayment” status, triggering interest capitalization.
☁️ Bucket 1: $145,000
☁️ Bucket 2: $0
From this point onward, your interest calculation will be based on the new capitalized student loan balance of $145,000.
Unlike other repayment plans, the Saving on a Valuable Education (SAVE) plan offers a unique benefit.
If your monthly student loan payment under the SAVE Income-Driven Repayment plan doesn’t cover the full interest owed, any unpaid interest is 100% forgiven. This exclusive feature distinguishes the SAVE plan.
For example, if your calculated SAVE payment is $300/month, but you would owe $1,000/month in interest without IDR, the $700 shortfall is entirely forgiven— it does not get added to your student loan balance.
In simpler terms, your student loan balance will never grow, even if your payment falls short.
This strategy is particularly advantageous for physicians not pursuing Public Service Loan Forgiveness (PSLF) and those in training. The key benefit is that unpaid interest doesn’t lead to an increase in your loan balance, allowing you to pay less towards your student loans since you are not obligated to cover the additional interest that accumulates.
If you were enrolled in Pay As You Earn (PAYE) or Income-Based Repayment (IBR), any unpaid interest would be added to your student loan balance. However, if you are going for PSLF, that will not matter because any unpaid loan balance is forgiven tax-free after making 120 qualifying payments.
Unlike other repayment plans, the Saving on a Valuable Education (SAVE) plan offers a unique benefit.
If your monthly student loan payment under the SAVE Income-Driven Repayment plan doesn’t cover the full interest owed, any unpaid interest is 100% forgiven. This exclusive feature distinguishes the SAVE plan.
For example, if your calculated SAVE payment is $300/month, but you would owe $1,000/month in interest without IDR, the $700 shortfall is entirely forgiven— it does not get added to your student loan balance.
In simpler terms, your student loan balance will never grow, even if your payment falls short.
This strategy is particularly advantageous for physicians not pursuing Public Service Loan Forgiveness (PSLF) and those in training. The key benefit is that unpaid interest doesn’t lead to an increase in your loan balance, allowing you to pay less towards your student loans since you are not obligated to cover the additional interest that accumulates.
If you were enrolled in Pay As You Earn (PAYE) or Income-Based Repayment (IBR), any unpaid interest would be added to your student loan balance. However, if you are going for PSLF, that will not matter because any unpaid loan balance is forgiven tax-free after making 120 qualifying payments.
Understanding how student loan interest accrues and capitalizes is important for managing your repayment strategy effectively.
By choosing the right plan, like the SAVE plan, you can potentially save on interest costs and prevent your balance from growing even when payments don’t cover all the interest.
For physicians, these strategies can be particularly beneficial, especially if you’re not pursuing PSLF.
With the right approach, you can keep your focus on financial security and reduce the impact of interest over time.
Disclosure: This content is for informational purposes only and does not constitute personalized financial advice. We recommend consulting with your tax and financial professional for tailored guidance.
Understanding how student loan interest accrues and capitalizes is important for managing your repayment strategy effectively.
By choosing the right plan, like the SAVE plan, you can potentially save on interest costs and prevent your balance from growing even when payments don’t cover all the interest.
For physicians, these strategies can be particularly beneficial, especially if you’re not pursuing PSLF.
With the right approach, you can keep your focus on financial security and reduce the impact of interest over time.
Disclosure: This content is for informational purposes only and does not constitute personalized financial advice. We recommend consulting with your tax and financial professional for tailored guidance.
Start Dreaming Bigger,
Finally Take Control of Your Student Loans!
Start Dreaming Bigger,
Finally Take Control of Your Student Loans!
It All Begins with a Diagnosis…
At Dream Bigger Financial, we’re dedicated to setting early-career physicians on the right financial treatment plan.
With a comprehensive diagnosis, we guide you towards financial peace of mind, ensuring you can be your best self for your loved ones and patients.
Considering financial planning?
We’re currently accepting new patients!
If you prefer self-diagnosing,
join us on social media!
We regularly share tips and tricks on lowering taxes, managing student loans, saving for retirement, and guiding you to live your best financial life.
Michael Putterman, CFP®
☁ Virtually serving clients nationwide ☁
It All Begins with a Diagnosis…
At Dream Bigger Financial, we’re dedicated to setting early-career physicians on the right financial treatment plan.
With a comprehensive diagnosis, we guide you towards financial peace of mind, ensuring you can be your best self for your loved ones and patients.
Considering financial planning?
We’re currently accepting new patients!
If you prefer self-diagnosing,
join us on social media!
We regularly share tips and tricks on lowering taxes, managing student loans, saving for retirement, and guiding you to live your best financial life.
Michael Putterman, CFP®
☁ Virtually serving clients nationwide ☁