education loan : increase a monthly student loan payment to save on interest
TRANSCRIPT
Increase a Monthly Student Loan Payment to
Save on Interest
Paying extra each month – even the cost of a cup of coffee – will save you money and help
you pay off student loans faster.
A few weeks ago, the Student Loan Ranger detailed that paying your interest before it
capitalizes saves you money on your student loans. Now let's look at how federal student loan
payments are applied and how understanding the way this works can also save you money in
the long run.
First, the basics: Federal student loans are heavily regulated, even down to the way payments
are applied.
Loan holders are required to apply payments first to any outstanding fees, such as late fees,
then to interest accrued to date and then to the principal. This requirement is similar to the
way other types of consumer debt, including many mortgages, apply borrower payments. You
can never request extra money be applied to the principal if you still owe accrued interest as of
the date the loan holder receives your payment.
The order in which payments are applied is why it seems at first that you are making little
progress paying down your debt. At the beginning of the loan's life, most of your payment will
go to interest – assuming you are on a standard, level repayment plan – and very little will apply
to the principal balance.
As you near the latter half of the loan term, however, you will notice that each monthly
payment decreases your balance faster and that the majority of your payment goes to the
principal of the loan. The reason for this? Math.
Remember, interest accrues daily on federal student loans. The common calculation for daily
interest is the principal balance multiplied by the interest rate, which is then divided by 365.25
(don't forget the leap year). This gives you the amount of interest your current outstanding
principal accrues each day.
That daily interest accrues in its own accounting line and does not affect your principal balance
unless – and until – that interest capitalizes. Let's consider an example loan with a $50,000
balance and a 5 percent interest rate on a standard 10-year repayment term. Over a one-month
period, $6.84 interest will accrue daily; on day 30, your accrued interest balance will be
$205.20.
If you have no late fees to satisfy and no other outstanding interest remaining from a lower
payment option, then your regular $530.33 monthly payment on day 30 will first pay the total
accrued interest. The remaining $325.13 of the payment will go toward your principal, leaving
you with a $49,674.87 loan balance and no accrued interest. Now instead of accruing $6.84 per
day in interest, you will only accrue $6.80 in interest.
Adding just $20 a month to your payment saves almost $1,000 in interest over the life of the
loan. You will also pay your loan off five months sooner. Add $100 a month to your payment
and you will save almost $4,000 in interest and pay the loan off by July 2024 – almost two years
early.
There are a few more rules to be aware of if you are going to make extra payments toward your
loan. Regulations require that any multiple of the required monthly payment push the due date
of the loan ahead by the appropriate number of months unless the borrower specifically
requests that it doesn’t.
Note that the payment applies the same way to principal and interest in either of the example
scenarios. This is because you cannot pay interest before it accrues.
If you are making only part of an extra payment, such as in these examples, the due date won’t
jump ahead until the total extra you have paid equals a monthly payment. So in our extra $100
example, every six months or so, the borrower’s payment due date would jump ahead one
month.
Student loan payment application is one topic that can be very confusing to student loan
borrowers. So, remember this basic tip to eliminate your debt faster: Paying a little extra each
month – even if it is just money you saved by bringing your lunch to work or making coffee at
home – can make your Education loan significantly more manageable.
Source: http://www.avanse.com/education-loan