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Prepaying student loans can help you save on interest and become debt-free faster. Many loans, including federal and private student loans, allow prepayment without penalties, but it’s essential to understand how to make extra payments effectively.
Whether you want to pay down principal directly, make biweekly payments, or prioritize high-interest loans, prepayment strategies can significantly impact your financial future. This guide explores the benefits of prepaying student loans and how to ensure that your extra payments are applied correctly.
Key Points
• Federal and private student loans in the U.S. allow prepayment without penalties, enabling borrowers to pay off their debt faster and save on interest.
• Ensure that any additional payments are applied directly to the loan principal by specifying this with the loan servicer, reducing overall interest.
• Prioritize extra payments toward loans with the highest interest rates to maximize savings over time.
• Check accounts regularly and review monthly loan statements to make sure prepayments are being applied correctly.
• Another way to potentially save money on student loans is by refinancing them, ideally with a lower interest rate. However, refinancing federal student loans makes them ineligible for federal benefits and protections.
What Is a Prepayment Penalty?
A prepayment is any extra amount you pay on your loans in addition to your regular required monthly payment. A prepayment penalty refers to fees you pay to your lender if you choose to make extra payments.
Generally, if you have private or federal student loans, you will not pay penalties if you prepay your student loans. In fact, lenders are banned from charging additional fees when you make extra payments.
If you’re planning (or hoping!) to pay off your loan in full, check with your loan servicer about the details and to get a payoff quote. A payoff quote is an estimate of how much you’ll need to pay in order to pay off the full loan amount.
Student Loan Prepayment Penalties
Borrowers who want to make prepayments may worry that there is a prepayment penalty on student loans. There isn’t — but here’s what to know.
Are Prepayment Penalties Common with Student Loans?
There are generally no prepayment penalties on student loans. Lenders are prohibited from charging prepayment penalties on federal or private student loans. The Higher Education Act of 1965 banned prepayment penalties for federal student loans. And in 2008, the Higher Education Opportunity Act (HEOA) amended the Truth in Lending Act (TILA), banning prepayment penalties for private student loans.
Why Lenders Might Discourage Early Repayment
Although they cannot charge prepayment penalties, some lenders might prefer it if borrowers didn’t pay their loans off early. That’s because the longer it takes to repay a loan, the more time interest accrues, and the more a lender might collect.
Additionally, for federal student loan borrowers who are repaying their loans on an income-driven repayment (IDR) plan or working toward student loan forgiveness, these programs typically require paying loans over a certain period of time, such as 20 to 25 years, or making a certain number of payments, like the 120 qualified monthly payments to achieve Public Service Loan Forgiveness, which generally takes at least 10 years. If a borrower repays their loans early, they miss out on the federal benefits, and the lender misses out on the money they may have earned over a longer loan term.
Prepaying Federal Student Loans
Federal student loans are loans lent to borrowers by the federal government; specifically, the Education Department. They include:
• Direct Subsidized Loans: These loans are for eligible undergraduate students with financial need.
• Direct Unsubsidized Loans: These are for eligible undergraduate, graduate, and professional students..
• Direct PLUS Loans: These are for parents who want to borrow money for their dependent undergraduate students (Parent PLUS Loan) and for eligible graduate or professional students (Grad PLUS Loan).
• Direct Consolidation Loans: Borrowers with eligible federal student loans who want to combine them into a single loan with one interest rate can opt for student loan consolidation.
Federal student loans go into repayment when you graduate, drop below half-time enrollment, or leave school
You’ll get a six-month grace period before you must make regular payments if you have Direct Subsidized, Direct Unsubsidized, or Federal Family Education Loans (FFEL). PLUS Loans require repayment upon disbursement unless you’re a graduate or professional student, in which case you’ll be placed on an automatic deferment while in school and for six months after graduating, leaving school, or dropping below half-time enrollment.
Once you graduate, you can choose from repayment plans that base your monthly payment on your income, or a fixed monthly payment over a set repayment period. Calculating your student loan payments can give you an estimate of how much you’ll pay on each plan.
You can prepay your student loans by making extra payments beyond your monthly payment whenever you have extra cash available. You can do that as often you like, whether you do so once a year, once a month, or biweekly. You can even prepay on your federal student loans while you’re in school or during your grace period, but note that these prepayments will not count as qualifying payments for federal loan forgiveness programs.
How to Make Sure Prepayments Are Applied Correctly
It’s important to know how your loan servicer applies prepayments so that you can make sure they are done the way you intend.
Requesting Payments Go Toward Principal
Student loan servicers usually apply your payments first toward any late fees you’ve incurred, then toward any outstanding interest (the amount your lender charges for borrowing), and last, toward your outstanding principal balance (the sum you originally borrowed).
When making prepayments, contact your loan servicer to tell them exactly where the money should go. You can instruct them to put the payment toward the principal. That way it will help reduce your loan balance, which in turn can reduce the amount of interest you’ll pay.
Also, consider making an extra payment right after you make your regular monthly payment, before interest starts accruing between one payment and the next. At that point, your lender will apply the entire prepayment amount toward principal, which again, will shrink the overall amount you owe in interest.
Finally, if you have more than one loan with that servicer, you can also direct them to put the prepayments toward the loan with the highest interest rate, which can help you save more money on interest.
Tracking Loan Servicer Activity
To be sure that the payments were applied correctly, check to make sure that the loan servicer followed your instructions. You can log into your online account with your loan servicer or lender to see your payment information. Also, review your statements each month to make sure the money is going where you want it to. If it’s not, contact your servicer.
Recommended: 6 Strategies to Pay Off Student Debt Loans Quickly
Prepaying Private Student Loans
Like federal loans, most private student loans also allow for prepayment without penalties. Still, it’s helpful to familiarize yourself with the specifics of your particular loans.
Reviewing Loan Terms for Prepayment Clauses
Most private lenders do not charge prepayment penalties. But read through your loan agreement carefully to make sure you can make prepayments without incurring any charges or having to meet specific conditions.
Also, look for information that spells out how loan prepayments are applied and any notification processes borrowers need to follow when making prepayments. See if you could pay off the entire loan early without penalty should you choose to do so.
As you’re reading over your loan agreement, be sure to note your interest rate and term. If they are less than ideal, you may want to consider the option to refinance your student loans.
With refinancing, you replace your existing loans with a private loan with new rates and terms. Depending on the student loan refinancing rates you qualify for, you may be able to reduce the interest rate, loan term, or both.You can refinance one loan, multiple loans, private loans, or a combination of federal and private loans. Just keep in mind that by refinancing federal loans with a private lender, you lose access to federal protections and benefits like forgiveness.
A student loan refinancing calculator can help you determine how much refinancing might save you.
Communicating Directly with Lenders
Tell your lender or loan servicer how to apply the payments to your private loans. Give them specific instructions on how to allocate your extra money. Keep a close eye on your online account and read your monthly statements so you know that your prepayments are going where you want them to.
Benefits of Prepaying Student Loans
There are notable benefits to prepaying student loans, especially when it comes to saving money.
Saving on Interest Over Time
By prepaying your loans and directing the extra payment to the principal balance of the loan, you can reduce the total amount of interest you’ll pay over the life of the loan, which could save you a substantial amount of money.
Paying Off Debt Sooner
Prepaying also allows you to repay your debt faster. It reduces the interest you pay since less interest will accrue than it would have over the full term of the loan. And consider this: The sooner you pay off your loan debt, the sooner you can start directing your money toward other financial goals.
Strategies for Effective Student Loan Prepayment
There are different methods you can use to prepay your loans. One or both of the following techniques may work for you
Using Windfalls and Bonuses
If you get a bonus at work, or you score a windfall — perhaps a relative gives you a generous birthday gift, for example — put that money toward your student loan payments. Any time you come into some extra cash, direct as much of it as you can to your loans to help pay them down faster and save money on interest.
Setting Up Biweekly Payments
With biweekly payments, you make two loan payments per month instead of one, paying half your student loan bill with each payment. You can time the payments to align with when your paychecks hit your bank account to make sure you’ll have the funds on hand.
With the biweekly payment method, you’ll end up making 13 full payments on your loan over the course of a year instead of 12, which can help pay down your principal faster, reduce the total interest you’ll pay, and shorten your loan term.
The Takeaway
Prepaying your student loans generally does not involve penalties or extra fees. This means you can pay off your loans as often or as quickly as you like, ultimately saving money on interest and getting out of the debt faster.
Be sure to contact your loan servicer to tell them how you want your prepayments applied. Then check your account and your monthly statements to make sure your instructions have been followed properly. While you’re at it, review your loan agreement to make sure you’re happy with your loan terms and rates. If not, you may want to consider other repayment methods or plans.
Looking to lower your monthly student loan payment? Refinancing may be one way to do it — by extending your loan term, getting a lower interest rate than what you currently have, or both. (Please note that refinancing federal loans makes them ineligible for federal forgiveness and protections. Also, lengthening your loan term may mean paying more in interest over the life of the loan.) SoFi student loan refinancing offers flexible terms that fit your budget.
With SoFi, refinancing is fast, easy, and all online. We offer competitive fixed and variable rates.
FAQ
Should you prepay student loans?
If you can do it, student loan prepayment can help you pay off your student loan debt faster, and save you considerable money on total interest paid over the life of the loan. Once you get out of student loan debt, you could turn your attention (and your resources) to other financial goals, such as buying a home and saving for retirement.
What about interest charges when you prepay student loans?
When you prepay student loans, ask your loan servicer to apply the extra payments toward the loan principal. This will reduce the loan balance, which is the amount on which future interest is calculated. It can save you money over time by lowering total interest charges.
Can you target specific loans when making extra payments?
Yes. Ask your loan servicer to direct your payments to the loans you most want to pay off — such as those with the highest interest rates, for example, to help you save more money on interest. If you have both federal and private loans, you may want to direct payments to the private loans first, so you can continue to have access to the federal benefits like forgiveness and deferment that come with your federal loans.
Will prepaying impact my credit score?
Making consistent payments on your student loans, including prepayments, can help strengthen your credit by building a positive payment history, which is the biggest factor in determining your credit score.
That said, paying off your loans early can temporarily lower your credit score by reducing your length of credit history and by potentially impacting your credit mix. However the slight drop in your credit score typically doesn’t last longer than several months.
Is it better to save or prepay student loans?
There is no one right answer to this question — it depends on a borrower’s unique situation. But in general, if the interest rates on your student loans are high, you may want to prioritize prepaying them to save money on interest. However, it’s important to have an emergency savings fund in place for any unexpected expenses that pop up. If you don’t have at least three months’ worth of expenses saved for that purpose, you may want to build your emergency fund first and then work on prepaying your loans.
Photo credit: iStock/BartekSzewczyk
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