Do You Know That Student Loans Are Compound Loans?

— From How Interest Grows, to Early Repayment Strategies and Refinancing Checklists

1) Why Student Loans Act Like Compound Debt

During school, grace, or deferment, unpaid interest accrues.
At certain points, that unpaid interest is capitalized (added to the principal).
Once capitalized, new interest accrues on the higher balance, creating a compound effect.
Some countries officially label loans as “simple interest,” but with capitalization events, the borrower experiences them as if they were compound loans.

Compounding is not evil — but ignoring it makes repayment much more expensive.

Scenario: Principal $20,000, interest rate 5.5%, repayment term 10 years

Standard Repayment (no extra payments)
- Monthly payment ≈ $217.05
- Total interest: $6,046
With $50 Extra Each Month
- Loan shortened by 28 months (120 → 92)
- Interest saved: $1,492

Capitalization Cost (if unpaid during 4 years of school):

👉 Takeaway: Avoid capitalization or shrink the principal early — this determines how much you’ll really pay.

Block capitalization: Even in deferment, pay the accruing interest.
Minimum + extra: Add $20–$100 per month consistently.
Principal-only payments: Ensure extra payments are applied to principal only, not future interest.
Use windfalls: Tax refunds, bonuses, side hustle cash → lump-sum payments.
Biweekly schedule: Split monthly payment in half and pay twice a month → reduces average balance.
Autopay discounts: Many lenders cut rates by 0.25% with autopay → saves hundreds over a decade.
Prioritize high-interest debt first: Clear credit cards or personal loans before accelerating student loans.

Rates drop significantly: Example, $24,400 balance, 10 years at 5.5% → 4.2%
- Monthly payment: $264.80 → $249.36
- Total interest saved ≈ $1,853
Shorter repayment term: Cuts total interest even if rate is unchanged.
Low fees and clear net savings.

What benefits will I lose?
- Federal protections, income-based repayment, forgiveness programs.
- Moving from fixed to variable rate exposes you to rising rate risk.
What are the costs?
- Prepayment penalties, origination fees, credit score impacts.
Compare apples-to-apples:
- Use EAR (Effective Annual Rate), not just APR.
- Compare NPV (net present value) of costs and savings.

👉 Rule of thumb: Refinancing a federal loan into private is risky unless the benefits lost are negligible compared to savings.

Build an emergency fund (3–6 months) first.
Then: Pay off high-interest debt (credit cards) → Accelerate student loan payments → Invest long-term.
Compare after-tax, risk-adjusted returns vs. guaranteed interest savings.
Don’t underestimate the value of peace of mind from being debt-free.

“Making minimum payments is enough.” → Capitalization + compounding make this costly.
“Refinancing is always a win.” → Losing protections or benefits may outweigh savings.
“Autopay doesn’t matter.” → Even 0.25% can save hundreds over 10 years.
“Extra payments roll over to next month.” → Must specify principal-only to reduce balance.
“Investing beats repayment.” → True only if returns consistently exceed loan rate after taxes and risk.

Step 1 | Know Your Loan

Step 2 | Cut Off the Snowball

Step 3 | Evaluate Upgrade Options