I often get contacted by people who are terrified and bewildered by their student loan balances. They originally borrowed a certain amount, and that balance has grown enormously over time. How is this possible? How did they get here? How is this okay?
Well, it has to do with how interest accumulates, how you are repaying your loan, and how things went wrong along the way (such as by defaulting). Let me walk you through an example where a student loan can double in under 10 years.
Sally takes out, say, $45,000 in federal student loans. In this example, let’s say that one-third of those loans, $15,000, are “subsidized” (meaning the government pays interest while Sally is in school) and the remaining $30,000 is “unsubsidized” (meaning interest accrues while she is in school). I’m going to give these loans an interest rate of 6.8%, a fairly average interest rate for federal student loans (current rates are lower, but they will increase again in the future).
STARTING BALANCE: $45,000
Step 1: While in School. Let’s say Sally is in school for 5 years, and for the sake of simplicity, I’m going to say she took out all of those loans during her first year. During those five years, no payments are due, and interest does not accrue on the $15,000 of subsidized loans. Interest does, however, accrue on the $30,000 of unsubsidized loans at 6.8%. That’s over $2,000 per year in interest accrual, and by the time Sally graduates after 5 years, her overall loan balance is $10,200 higher than it was when she started, all because of interest.