Understanding student loan interest is vital to managing your debt. Here's how it works

• Student loan interest is the fee you pay to borrow, whether from the government or a private lender.
• While the money you pay in interest may seem small at first, it adds up over the life of the loan.
• Student loan interest generally begins accruing as soon as the loan funds are disbursed.
• Read more stories from Personal Finance Insider.

When borrowing money for college, some students might tend to focus on their total loan balance and allow the interest to get lost in the fine print. That can be a big mistake. Understanding your loan's interest rate is a key part of managing a debt that you're probably going to be paying off for at least a decade.

What is student loan interest?

Put simply, student loan interest is a percentage of your total loan balance that is essentially the fee for borrowing money. The interest rate you'll receive will vary depending on the type of loan and your lender. The federal government offers three separate set rates to undergraduate students, graduate and professional students, and parents of undergraduates. Interest rates vary significantly across private lenders. 

While the percentage of money you pay in interest can seem small at first glance, it can really add up over time.

"What a lot of people experience is they could be in repayment on their loans for a couple of years and never reduce the principal," says Stacey MacPhetres, senior director of education finance at workforce education program provider EdAssist Solutions. "Generally speaking, the reason for that is you're paying your interest first." 

The good news is that you may be able to deduct as much as $2,500 of student-loan interest on your federal income tax return, depending on your particular situation. You must have less than $85,000 in modified adjusted gross income, or $170,000 if filing a joint return, to qualify for this deduction. 

"Student loan interest is tax deductible," says Leslie Tayne, a financial attorney who specializes in student loan debt. "Students will receive federal tax documents from the bank or from the lender with the amount that should be included with your tax return."

You can learn more about the tax deduction policies from the IRS. 

How to calculate student loan interest

The way federal lenders and some private lenders determine your interest payments varies. All federal lenders use simple interest, as do many private lenders. 

The first payment you make on a simple-interest loan covers interest charge for the month, with the remainder going toward reducing the principal amount. Any unpaid interest does not add up from one month to another like compound interest.

Here's how simple interest works, assuming you have a fixed-rate loan (a variable rate loan does not have consistent payments). 

Use this calculator to plug in the numbers for your individual situation and see how much interest you'll pay. 

When does student loan interest begin accruing?

Generally, interest starts to accrue as soon as your loan funds are disbursed for private student loans and for most federal student loans. The exception is direct subsidized loans, which are interest-free (subsidized by the Department of Education) until your repayment period begins. 

However, many borrowers may not know that you can pay off the interest while in school and during your six-month grace period to prevent it from capitalizing at the end of that time. Capitalized interest is unpaid interest added onto your loan balance after periods of nonpayment. This will increase your overall loan balance, and you'll later pay interest on that higher amount, increasing the total cost of your loan.

"You could pay the interest while you're in school," says Marguerita Cheng, a certified financial planner and CEO of Blue Ocean Wealth. "But I'm here to say every situation is unique. What I mean is if you're an engineering student and your coursework is really hard, maybe it's okay to not pay the interest and focus on doing well in school. I know sometimes people like absolute advice, and if you can pay the interest, pay it. But every situation is truly unique."

How do I get the best student loan interest rate?

The best rates you can get on student loans are almost always with federal loans. Additionally, you'll get protections with federal loans you wouldn't otherwise get with private loans, like different types of repayment plans and loan-forgiveness options.

Keep in mind that you can't negotiate federal loan interest rates. They're set each year for every borrower, and creditworthiness doesn't factor in to the rates. Federal student loans first disbursed on or after July 1, 2021, and before July 1, 2022, are offered at three different rates:

While federal loans are usually a better option than private loans, you do have the option to go rate shopping with private loans. For private loans, the better your credit, the lower your rate. If you can't qualify or are looking to get an improved rate, enlist a cosigner with great credit. 

Will my student loan interest rate change?

Rates on each individual federal rate may change year over year, but once you take out a federal loan, its rate will remain fixed for the life of the loan. Private student loans can have either fixed or variable interest rates, which are altered periodically.

"A lot of people make the assumption that they will have one interest rate for all of their loans," MacPhetres says. "But you could have one rate your freshman year, different rate your sophomore year, and so on and so on. Understand that they are fixed-rate loans, but they in fact can change from year to year."