Making principal-only payments on student loans every month—or any time you can afford to—can help speed up the payback time on educational debt. But, to maximize the impact of extra payments, borrowers may want to take one more step—ask the lender to apply additional payments strictly to the loan principal.
More of your money in this case goes right towards paying down the initial loan amount and not simply to the interest that keeps on accruing, thereby speeding up how quickly you might repay what’s been borrowed.
Why Making Extra Payments Can Make a Difference
When a borrower takes out a loan, payments are generally determined by three variables: the principal, the interest, and the term of the loan. The principal is the amount of the loan, or how much is being borrowed. The interest rate is what the lender charges for providing the money, expressed as a percentage of the principal. The term is the expected amount of time the loan will be in repayment.
When the loan is new, the principal is at its highest. At this point, the interest accruing on the principal is higher, too. When a borrower begins making fixed monthly payments, more of the payment goes toward the interest—while a smaller amount is applied to the principal. As time passes, your minimum monthly payment may stay approximately the same (as long as it gets made on time), but the portion allocated toward the interest may begin to shift towards paying down the principal.
As the amount borrowed gets repaid, the interest you pay would go down as well. So, more and more of each monthly payment eventually gets applied to the loan.
The longer it takes to pay off a student loan, however, the more interest can keep accruing. Some loans begin accruing interest before the student even leaves school. And, interest can add up fast—which is why it might feel like Groundhog Day every time you open a student loan statement to check your balance.
By making larger regular payments, borrowers can pay off their loans faster. In the process, you—the borrower—might reduce your total costs. But, can you make principal-only payments on student loans? Unless a lender is given special instructions on where to apply your extra money, the additional payment could count towards what’s due next month.
In practice, this can mean that your extra money would go first toward the interest, any fees owed, and finally the principal. If you specify that the extra is meant instead as a “principal-only” payment (and the lender agrees to this), the additional money would be applied to the initial amount borrowed—speeding up the payback time on the original student loan debt.
To be clear: a borrower’s regular minimum payment would still be applied to interest and principal each month. Only extra amounts on top of this can then be designated as a principal-only student loan payment.
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How to Make Principal-Only Payments on Student Loans: Steps to Consider
It might take a few phone calls and emails to find out how to make principal-only payments on student loans, or if the strategy will be allowed by the lender. Here are some potential steps to consider:
Borrowers who have only one student loan could start by phoning their loan provider to discuss the rules for extra payments. Borrowers could be required to write an email or letter, fill out a form, click on a box online, or designate their wishes in some other official manner.
There may be a fee involved, or the timing of extra payments may be specified. For example, it might be necessary to send the extra payment at the same time as your regular payment to avoid having it first applied to the interest that accrues in between payments.
Borrowers with multiple loans might want to begin by reviewing their various balances and interest rates to determine which loan they hope to chip away at first. How might borrowers go about deciding where to start? Putting extra payments toward the loan with the highest interest rate—the debt avalanche method—may appeal to borrowers who want to reduce the total interest they’ll end up paying.
Other borrowers may prefer prioritizing the loan with the smallest balance, which could be more psychologically motivating. Once an approach has been picked, borrowers can contact their lender to inquire about making principal-only payments. During this communication, borrowers would still make regular monthly payments on all their loans.
Even when a lender allows principal-only payments and has a system in place to manage them, borrowers may encounter an occasional obstacle while transitioning to this repayment strategy. Borrowers might need to become even more conscientious about confirming that their payments were processed as requested, and some follow-up may be required with individual lenders.
What If You Can’t Make Principal-Only Payments?
If a lender doesn’t accept principal-only payments, a borrower can still make extra payments and work with the lender to direct the money to a specific loan. The Consumer Financial Protection Bureau (CFPB) provides payment tips and a sample letter on its website for borrowers who need guidance on what to ask for.
The CFPB also advises borrowers to consider signing up for auto-debit (if they haven’t done so already) to avoid potential late payment fees and to take advantage of any rate reduction the lender might offer to those who select auto-debit.
Borrowers with federal student loans have several repayment options to choose from, most of which are income-driven. One possible drawback to income-driven plans, however, is that they typically involve a long repayment period (20 to 25 years). Over the life of the loan, borrowers may still pay a significant amount of money towards still-accruing interest.
For borrowers repaying private loans, the CFPB suggests considering refinancing as an option.
Borrowers who look into student loan refinancing may find they can trade one or more old student loans for a new private loan with a lower interest rate, a shorter loan length, or both. Those who have a combination of private and federal loans also may find it’s possible to consolidate them into a single more manageable payment with a refinanced loan.
It’s important to note, though, that by refinancing federal loans with a private loan, a borrower could lose certain protections such as deferment, forbearance, forgiveness, and access to income-driven repayment programs. Still, for borrowers who don’t think they’ll qualify for such programs, refinancing can help individuals to pay less in interest over the length of their loans.
When borrowers refinance their student loans, they have the potential for a credit “do-over” based on fresh information. The private lender will take a look at their credit history, earning potential, and other financial factors to determine their new interest rate. Those who have improved their circumstances since college (with additional degrees, a higher-paying job, and healthy financial track record) may be surprised by their new creditworthiness.
Benefits to Paying Extra Payments
Student loans are sometimes referred to as “good debt,” because they can help people attain the education needed to pursue the career or lifestyle they want. Student loan interest rates are typically lower than on other types of debt.
If borrowers make student loan payments on time, it can help establish a good credit history early on. But, if your student loan debt load is high and the loan term is long, paying off these loans can become a slow and expensive slog that might derail future plans.
Borrowers who can reduce existing debt faster by making extra payments, applying the extra to the loan principal, or refinancing to a shorter term may reap several benefits. Some possible benefits to consider here might include:
Debt-to-income Ratio May Go Down
Lenders consider a borrower’s debt-to-income ratio—the amount of debt they have compared to overall income—when determining whether to approve a car, mortgage, or another type\ of installment loan. Maintaining a lower DTI ratio could boost an individual’s chances of being approved for a loan. There are two main ways to achieve a lower DTI ratio: by decreasing your monthly recurring debt or increasing your gross monthly income. By lowering or eliminating student debt, borrowers can improve their DTI ratio and potentially improve their status with lenders.
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Credit Score May Go Up
Lenders look at credit scores to help gauge a borrower’s ability to make payments. A higher credit score can help with obtaining a lower interest rate. Student loans, which are installment loans, are included on credit reports. Responsibly managing this type of debt can help increase credit scores over time.
Savings Potential Could Improve
As student loan bills diminish and disappear, it can free up more money for other expenses and boost a saver’s ability to build up key savings goals such as an emergency fund, retirement account, down payment on a house, or other short- and long-term financial goals.
The thought of finding extra money every month to pay down student debt may be daunting. But the benefits could make it worth both the added effort and initial expense. Those who don’t think they can eke another loan payment out of current earnings might consider making an occasional extra payment with a tax refund, work bonus, or some other unexpected (and unbudgeted) money.
If you’re determined to put a bigger dent in your student loans, make a plan! There are numerous sound student loan payoff strategies and resources exist that could lower your existing educational debt.
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