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Understanding Loans: Student Loans and Interest

Student loans are different than car loans and mortgages because the majority of student loans allow you to defer repayment while you're attending school on at least a half-time basis. While this is a convenience if you are unable to make payments while attending classes, it also means that you could end up paying much more. Unpaid interest can capitalize (be added to) your principal balance and can significantly increase your loan balance from the time you take out a loan until you begin repayment.

For example, a $5,000 loan with a 6.00% interest rate accrues $300 in interest in one year. That may not seem like much, but if you take out that $5,000 loan your freshman year, do not take out any other loans and do not make interest payments while you're in school, that $5,000 loan can increase to a principal balance of more than $6,300 in four years because interest was charged on top of interest over time. (This example assumes interest is capitalized once per year.)

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