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As students across the country prepare to head back to school, financial planning often takes a back seat to textbooks, class schedules, and extracurricular activities. However, understanding how to manage your student loans while you're still in school can save you a significant amount of money in the long run—especially when it comes to interest capitalization.
What is Interest Capitalization?
Interest capitalization occurs when unpaid interest is added to the principal amount of your loan. When this happens, you're not just paying interest on your original loan amount; you're also paying interest on the interest that has accumulated. This can result in your debt growing faster than you anticipated.
The good news? There are ways to avoid this from happening while you’re still in school.
Avoiding Interest Capitalization: Start Small, Start Early
As I shared in a recent CNN Underscored article, one of the best things you can do to avoid interest capitalization is to make extra payments on your student loans before they even become due. Many students work part-time jobs over the summer, during school breaks, or even throughout the academic year. If you find yourself with extra money, consider putting a portion of it toward your loans.
Even small amounts can make a significant difference over time. For example, making extra payments towards your loan while you’re still in school can reduce the interest that accrues and prevent it from being added to your principal when your repayment period starts. You don't need to wait until you graduate to start making payments!
Timing is Key
Once you’re actively repaying your loan, the timing of your payments can also help reduce the amount of interest that accrues. You don’t have to wait until the payment due date—making a payment earlier in the month could help decrease the amount of interest that accumulates, especially if you continue making extra payments when possible.
Should You Refinance Your Federal Loans?
Another question many graduates face is whether they should refinance their federal student loans. The decision largely depends on your financial situation. If refinancing could secure you a lower interest rate or smaller monthly payment, it might be worth considering.
However, it's important to remember that refinancing often means extending the length of time you'll be paying off your loan. A useful strategy to mitigate this downside is to continue making the same payments you were before refinancing. This way, you’ll reduce the principal more quickly, saving you money in interest payments over the life of the loan.
Why Are Federal Student Loan Interest Rates So High?
You may be wondering why interest rates on federal student loans seem so steep right now. A combination of inflation and rising college costs is largely to blame. As college tuition skyrockets due to higher operational costs at universities, students are borrowing larger sums of money. On top of that, inflation pushes interest rates higher, adding to the financial burden.
That’s why it’s critical to minimize the amount you borrow. Consider taking on part-time jobs, attending school part-time while working, or seeking out scholarship opportunities. Every bit counts when it comes to reducing your overall loan amount and managing your repayment after graduation.
Back to School Financial Planning
As you prepare for another semester, remember that financial planning should be part of your back-to-school routine. Take proactive steps to manage your student loans now, whether that’s making extra payments, timing your loan repayments strategically, or considering refinancing when appropriate. With a little effort, you can ease the financial strain down the road and make the transition from college to career that much smoother.
Remember, it’s never too early to start making smart financial decisions—and every little bit helps!
Have questions or want personalized financial advice? Our team would love to talk. Request an appointment and we'll be in touch.
About the Author:
David Peters, CPA, CFP, ChFC, CLU, CPCU, CGMA, is the Founder and Owner of Peters Professional Education (petersprofessionaleducation.com) and Peters Tax Preparation & Consulting, PC. David Peters is also registered with the U.S. Securities and Exchange Commission (SEC) as an Investment Advisor Representative (IAR) with Peters Financial LLC. He regularly teaches courses in accounting, finance, insurance, financial planning, and ethics throughout the United States, and regularly contributes regularly to various professional publications, including NCACPA’s Interim Report, SCACPA’s CPA Report, and VSCPA’s Disclosures.
Required Disclosure:
The content presented above is for informational purposes only, is general in nature, and is not intended to and should not be relied upon or construed as a financial plan or financial/investment advice regarding any specific issue or factual circumstance.
Financial and investment advisory services offered through Peters Financial LLC. Brokerage and custodial services offered through Charles Schwab Co. Inc., member FINRA and SIPC. Peters Financial LLC and Charles Schwab Co. Inc. are not affiliated. David Peters also offers tax services through Peters Tax Preparation & Consulting, PC. Peters Tax Preparation & Consulting, PC is not affiliated with Peters Financial LLC and clients or prospective clients are never obligated to use Peters Tax Preparation & Consulting, PC. as part of any financial planning or investment management services offered by Peters Financial LLC.
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