Every dollar you borrow will cost about two dollars by the time you repay the debt.

The financial aid “refund” is not free money if it includes the proceeds of any student loans. It will have to be repaid, usually with interest.

So, before you use student loan money to pay for something, ask yourself if you’d still buy it at twice the price.

Derivation of the Rule of Thumb

This rule of thumb depends on the typical mix of interest rates, loan fees, capitalized interest and repayment terms for federal and private student loans.

When you borrow money, you repay it with interest. So, the total payments over the life of the loan will be greater than the amount originally borrowed.

For example, every percentage point of interest increases the total payments by 10 to 12 times the interest rate, if we assume a 10-year repayment term. A 5% interest rate increases the total payments by 51% and a 10% interest rate increases the total payments by 110%.

Loan fees increase the total payments by a bit more than the amount of the fee. The exact increase is 1/(1 – Fee) – 1. For example, 4% in loan fees increases the total payments by 4.2%.

Don’t forget about interest capitalization. Most borrowers do not make any payments on their student loans during the in-school and grace periods. This typically involves 32 months of interest being added to the loan balance, on average. So, multiply the interest rate by 2.67 to determine the increase in total payments. For example, capitalized interest increases total payments by 13% for a 5% interest rate.

Most borrowers do not repay their student loans over a standard 10-year repayment term. Instead, they choose the lowest monthly payment available to them, which yields the longest available repayment term, typically a 20, 25 or 30-year repayment term. This increases the total payments by about 5 times the interest rate for a 20-year repayment term, about 7 times the interest rate for a 25-year repayment term and about 10 times the interest rate for a 30-year repayment term. For example, at a 5% interest rate, a 20-year repayment term increases total payments by 24%, a 25-year repayment term by 38% and a 30-year repayment term by 52%.

Throw all these numbers in a blender, and you get a table similar to this one, which shows the relationship between the total payments and the amount originally disbursed. Each column corresponds to the specified repayment term in years and each row corresponds to the specified interest rate. This table assumes loan fees of 1%.

 

10 Years

15  Years

20  Years

25  Years

30  Years

1%

1.1

1.1

1.1

1.2

1.2

2%

1.2

1.2

1.3

1.4

1.4

3%

1.3

1.4

1.5

1.6

1.7

4%

1.4

1.5

1.6

1.8

1.9

5%

1.5

1.6

1.8

2.0

2.2

6%

1.6

1.8

2.0

2.3

2.5

7%

1.7

1.9

2.2

2.5

2.9

8%

1.8

2.1

2.5

2.8

3.2

9%

1.9

2.3

2.7

3.2

3.6

10%

2.0

2.5

3.0

3.5

4.0

11%

2.2

2.7

3.2

3.8

4.5

12%

2.3

2.9

3.5

4.2

4.9

13%

2.4

3.1

3.8

4.6

5.4

14%

2.6

3.3

4.1

5.0

5.9

15%

2.7

3.6

4.5

5.4

6.4

 This table does not consider that most borrowers will obtain a few months or years of deferment or forbearance at some point during their repayment term.