Making Principal Payments on Student Loans

Making Principal Payments on Student Loans

Paying MORE than the minimum payment on your student loan saves you money and helps put you on the path to financial stability.

77% of borrowers we surveyed said they were making little progress in paying down their student loans.  There is hope.  Actually, the CARES Act pause offers borrowers a once-in-a-lifetime opportunity to quickly pay down student loans. The key is to know how to pay down principal.

To give you a better idea about how much money you can save, review this example of a student loan for $20,000, where the borrower is making extra payments. In this example, if you pay $200 a month above the minimum payment, you would pay off your loan 5 years sooner and pay $4,247 or 55% LESS in interest.

That is pretty amazing!

But simply sending in extra money on your payments does NOT mean that money will be applied to your loan principal.  It will take effort on your part to make sure your payment is applied correctly.

PRINCIPAL PAYMENT HINTS

Make Interest-only Payments  Making interest-only payments while you are in school will reduce the amount of interest you accumulate and keep your loan balance lower.

The same concept applies when you make payments during the CARES Act when interest accrual is paused.

Know What You Owe  Borrowers often have many loans, and that makes it challenging to figure out how much is owed. A good practice is to write down the following:

1.  Make a list of all your loans including the current balance of each loan
2. Write down the interest rate on each loan
3. Write down the minimum payment

Develop a Strategy  Choose which loan you want to pay off first.  It may be the loan with the lowest balance, but most borrowers concentrate first on paying off the loan with the highest interest rate.  After the highest interest loan is paid, the borrower takes the money for the payment that would have gone toward that loan and puts it ALL toward the next loan they wish to pay off.  That method is referred to as the avalanche method combined with the snowball method.  Most experts say it is the most productive way to pay off debt.  In the chart above, adding $600 per month to your minimum payment is an example of this method and shows that you could pay off your loan almost 8 YEARS earlier!

Communicate with Your Servicer  Contact your loan servicer and let them know you want to pay additional payments toward the principal of your loan.  It is your responsibility to make sure your payments are processed correctly.  Student loan payments are set up so that interest and fees are paid first from each monthly payment.  Most servicers then automatically apply additional payments to future payments or other loans, so specify that your additional payment is for Principal Reduction.

Please know that you need to communicate in writing how your payment should be applied. Also, keep a copy of any communication you have with your lender on that subject.  The Consumer Financial Protection Bureau has a helpful article here with a link to a sample letter to help you communicate with your servicer.

Tick the Right Options  When making payments in your online account, you may see the option “Do not advance the due date.”  If you select that option, your payment should be treated as an extra payment to principal and should not be used to cover the next month’s payment.

Stagger Your Payments  Alternatively, the Student Loan Ranger recommends that you make your regular payment on time, and then send extra payments a day or two AFTER receipt of your payment has been confirmed.  Write a separate check and in the notes section write that it is for “principal reduction.”  Because your regular payment has been received, extra payments you send should be applied to the principal balance on the loan you specify.

Follow Through. Check your account online to make sure that your payments are applied properly with a “for principal reduction” notation.  If the payment was not properly applied, immediately contact your servicer.

Bottom Line?

Paying Principal Makes a MASSIVE Difference

Paying principal will save you money and time; it will make a massive difference in the amount of time it takes to pay off your loan and the amount of interest you pay.

It does take effort and regular communication with your servicer to make sure your payments are correctly allocated, but it is worth it!

Read More About The CARES Act and Student Loans

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