Lana Oconnell
Making extra payments on your student loans can help you save on interest and speed up the payback time, but they need to be applied only to your principal. Generally, student loan servicers apply your payments first to cover any late fees and then to accrued interest before they apply anything to your principal. Therefore, it is important to understand how student loan payments are applied to strategize a repayment plan that can save you thousands over the life of the loan.
| Characteristics | Values |
|---|---|
| How to make principal-only payments | Making extra payments on your student loans can help you save on interest, but you need to ensure that these payments are applied only to your principal. |
| How to ensure extra payments go towards the principal | If you pay online, you may be able to choose how the money is applied. You may see an option to enter an "other amount" where you can specify how much you want to pay towards your loan that month and where that money should be applied. |
| Prepayment penalties | Student loans have no prepayment penalties. This means that if you make an extra principal-only payment, it will lower the principal balance of your loan, and the lender will not be able to charge you a fee for paying off your loan early. |
| How interest accrues | Interest on the vast majority of student loans accrues on a daily basis based on your balance that day. |
| How to pay off multiple loans | If you have more than one student loan, you can typically request that your student loan servicer apply your extra payments to a specific loan (such as the loan with the highest interest rate) to ensure you can save money and meet your debt repayment goals. |
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What You'll Learn
Making extra payments
First, understand the difference between paying off the principal and paying interest. When you make a payment, it is generally applied first to any fees or collection costs that might be outstanding, then to accrued interest, and finally to the principal amount. Paying extra will reduce the principal faster and limit the interest that can accrue.
Notify your loan servicer that you want the extra funds to go toward the current principal balance. You can do this by including a note with your payment or by contacting the servicer directly. If you don't specify, the extra payment may be treated as an early payment for the following month, or it may be held and applied to future payments, reducing the amount of your regular monthly payment.
Consider making a lump-sum payment directly to the principal. This can be done by sending a cheque or paying online through your student loan account. Make sure to indicate that you want the payment applied to the current principal balance.
If you want to make regular extra payments, you can increase the amount of your monthly payment. Contact your loan servicer to set this up and specify that you want the extra amount to go toward the principal.
You can also make separate, additional payments throughout the month. Each payment will cover that month's interest first, but any extra will go toward the principal, helping you pay off your loan faster.
By making extra payments towards your student loan principal, you can reduce the overall cost of your loan and accelerate your progress toward becoming debt-free.
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Reducing overall borrowing costs
Borrowing costs can be reduced by lowering the amount of debt, cutting borrowing costs, and cutting repayment costs. Here are some strategies to reduce overall borrowing costs:
- Borrow less: The less you borrow, the less you will have to repay. Try to limit your borrowing to no more than your expected starting salary in your field of study. This will make it easier to repay your loans within a standard 10-year repayment plan.
- Save before college: Every dollar you save is a dollar less you'll have to borrow. Consider college savings plans to reduce your overall debt.
- Focus on free money: Reduce the need for student loans by applying for grants, scholarships, tuition waivers, and tuition tax credits.
- Choose lower-cost loans: Federal student loans typically have lower fixed interest rates and better repayment terms than private student loans. Additionally, subsidized loans are preferable to unsubsidized loans as the federal government pays the interest during in-school, grace, and deferment periods.
- Make principal-only payments: Making extra payments on your student loans can help reduce the overall borrowing costs. Ensure that these extra payments are applied to the principal amount and not future interest.
- Loan consolidation: Combining multiple loans into a single payment can result in a lower interest rate, simplifying your payments and lowering overall costs.
- Shorten the loan term: Opting for a shorter loan term will reduce the total interest you pay over time. However, this comes with the trade-off of higher monthly payments, so it's important to balance affordability with your financial situation.
- Make a larger down payment: A larger down payment can lower the overall loan amount and interest rate. It demonstrates responsible money management, making you a less risky borrower.
- Sign up for AutoPay: Many lenders offer a slight interest rate reduction (0.25% or 0.50%) as an incentive for automatic monthly payments.
- Understand interest accrual and payment application: Know how interest accrues daily and how payments are applied to fees, interest, and principal. This knowledge will help you strategize efficient repayment plans.
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Avoiding prepayment penalties
There are no prepayment penalties for federal or private student loans. Lenders are banned from charging additional fees when a borrower makes extra payments on their student loans or pays off the student loan balance early. This is thanks to the Higher Education Opportunity Act of 1965, which states that students who take out a loan may “accelerate without penalty repayment of the whole or any part of the loan”. In 2008, the Act was revised to ban prepayment penalties for private student loans as well.
However, there are a few additional steps to ensure that student loan prepayments are applied to the principal balance of the loan with the highest interest rate. This is because, when a lender receives payments on a loan, the payment is applied first to late charges and collection costs, then to outstanding interest, and then to the outstanding principal. Therefore, it is important to include a note with any prepayment indicating that you want the prepayment applied to reduce the principal balance of the loan. Otherwise, the lender will treat it as though you had paid your next instalment(s) early, and may delay the next payment due date(s) as appropriate.
It is always better to have prepayments used to reduce the loan balance, since this will cost you less over the lifetime of the loan. Due to the way the income-contingent and income-based repayment plans treat interest, it is not advisable to prepay a loan in these categories. If you have several loans with the same lender, you may wish to specify that the extra payment be applied to a specific loan. Generally, if the extra payment is applied to the highest-cost loan (e.g. the one with the highest interest rate), you will save the most money.
Before prepaying your student loans, it is important to ensure that you have the financial flexibility to do so and that all other loans and debts are paid off first. Student loans usually do not have as high an interest rate as other types of loans or debt (such as credit cards). Therefore, you should prioritise higher-interest loans or debts over student loans.
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Understanding how interest accrues
When making minimum monthly payments, a portion goes towards the interest, and the rest reduces the principal balance. Initially, most of your payment will go towards interest, with a small amount reducing the principal. Over time, however, this balance shifts, and a larger portion of your monthly payment will be applied to the principal, reducing the interest portion.
To save on interest costs, you can make extra payments towards the principal. This strategy is known as a principal-only payment. By law, lenders cannot charge prepayment penalties for student loans, so you can make extra payments without incurring fees. However, some lenders might require interest to be paid first, so it's important to specify that any extra payments should be applied to the principal.
To ensure your extra payments are applied correctly, you may need to take additional steps beyond just sending extra money to your lender. Communicate your specific instructions to the lender and regularly check your online accounts and statements to verify that your extra payments are reducing the principal as intended. Some lenders allow you to select "principal-only" as a payment method on their website, making it easier to allocate your extra funds.
Making principal-only payments can significantly reduce your overall borrowing costs and help you pay off your student loans faster. It lowers your principal balance, resulting in lower interest charges over time. However, it's important to note that making extra payments might not lower your future monthly payments.
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Strategies for multiple loans
Having multiple student loans can be overwhelming, but with careful planning and consistent effort, you can successfully manage your debt. Here are some strategies to help you tackle multiple student loans:
Understand your financial situation
Get a clear understanding of your monthly income, expenses, and other debts. This will help you determine a realistic monthly loan payment amount that fits your budget. Create a detailed list of your income and expenses, including your student loan payments, and try to balance the two. Categorize your expenses into fixed costs (e.g., rent, utilities) and variable costs (e.g., groceries, entertainment). This will give you a clear picture of your spending habits and help you identify areas where you can cut down on expenses.
Know your loans
Compile detailed information about each of your student loans, including the lender, loan balance, interest rate, and minimum monthly payment. Understanding the terms and conditions of each loan will help you make informed decisions about repayment strategies and prioritizing loans. Know the difference between federal and private student loans. Federal loans usually offer more benefits, such as deferments, income-driven repayment plans, and loan forgiveness opportunities, while private loans may have higher interest rates and less flexibility.
Choose a repayment strategy
There are several repayment strategies that can help you manage multiple student loans:
- Debt avalanche method: This strategy focuses on paying off the loan with the highest interest rate first while making minimum payments on all other loans. This can save you money on accrued interest over time.
- Debt snowball method: This approach involves paying off the smallest loan balance first and then rolling that payment into the next highest balance. This method can help you stay motivated by providing a sense of accomplishment.
- Consolidation or refinancing: You can apply for a new loan to combine all your existing loans into one, making it easier to manage with a single monthly payment. This may also result in a lower interest rate.
- Biweekly payments: Instead of making one full monthly payment, you can pay half of your bill every two weeks. This results in an extra payment each year, reducing the overall repayment period and interest costs.
- Automatic payments: Setting up autopay can help you stay on top of your payments, avoid late fees, and even qualify for a small interest rate discount offered by some lenders.
Remember, the key to successfully managing multiple student loans is to stay organized, understand your financial situation and loan terms, and choose a repayment strategy that works best for you.
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Frequently asked questions
Making a principal-only payment on your student loan can be done in several ways. You can pay online through your loan servicer’s website, where you may have the option to choose how the money gets applied. You may also have the option of setting up standing instructions online, telling your servicer to send any extra money toward the principal. If you pay by check or don’t see these options online, you’ll need to contact your loan servicer and ask how to make occasional or regular principal-only payments.
Making a principal-only payment on your student loan can help speed up the payback time and lower your overall borrowing costs. This is because interest on a student loan is calculated daily on the principal balance at that time, so the less principal you have left to pay, the lower your interest costs.
You typically need to take a few extra steps to ensure that your extra payments go towards the principal and not future interest. When you pay extra beyond your monthly payment, that payment is often marked as “paid ahead” status, and the lender may simply apply it to next month’s bill. You can avoid this by asking your lender to make principal-only payments on your student loans, or by specifying how you want your extra funds to be divided.
