Two hundred and thirteen percent. That’s how high tuition at public four-year institutions has grown since 1988. With that rise in tuition comes a rise in student loan debt as well—a financial strain that affects so many people in the LCMS, including students, parents, pastors, deaconesses, teachers, directors and so on.
Thus, understanding how payments are applied towards student loans can help you save money in the long run. Let’s explore the rules of student loan payments.
How your payment is applied
Student loan payment application rules are set in federal regulation. That means payments must be applied, with very few exceptions, first to any outstanding fees (such as late fees), then to interest that has accrued to date. Finally, any money left is applied to the principal. These rules apply regardless if you are paying your minimum required payment or additional amounts.
You are also required to pay towards all loans at the same time. You can, however, control where additional amounts beyond the minimum will go. So, if your required monthly payment is $100 for three loans and you pay $150, you can designate to which of the three loans that extra $50 will go to.
How to pay less by paying extra
Interest on your student loans accrues on a daily basis off of whatever your principal balance is on that day. Therefore, reducing the principal faster reduces the total amount of interest you will pay over the life of the loan.
Imagine on May 1 your principal loan balance is $20,000, the interest rate is 5% and the minimum monthly payment is $200 per month. On April 30, for the purposes of this example, the accrued interest balance is zero. On May 1, the loan is accruing approximately $2.74 in interest per day. On May 2, the principal is still $20,000, but the interest balance is now $5.48. On May 30, the principal is still $20,000, but the interest balance is $82.14 (30 days x $2.74).
On that day, the loan holder receives your $200 payment. There are no late or other fees so $82.14 goes to interest, bringing that interest balance back down to zero, and the rest ($117.86) goes to principal, bringing that balance down to $19,882.14. Now you are accruing $2.72 per day in interest.
Thirty days later another payment arrives, and your interest balance is only $81.65, which means even more of your payment will go to principal than the last one. If you had paid even an extra $25, that amount would have been even lower. As you can see, all of these little bits can really add up to significant interest savings over the life of the loan.
“Reducing the principal faster reduces the total amount of interest you will pay over the life of the loan.” – Betsy Mayotte, President, Institute of Student Loan Advisors
Your due date will be pushed forward
Federal regulations also require that when the loan holder receives more than your minimum monthly payment amount, they must push your due date forward. This does not affect how your payment is applied to principal and interest but could complicate other things such as payments used to qualify for Public Service Loan Forgiveness (paid ahead payments don’t count for PSLF) or if you are using an automatic debit tool through your loan holder. However, borrowers paying extra can always request not to be in a paid ahead status via phone call, email or, sometimes, just by logging into their account.
Benefits of paying ahead
Some borrowers become worried when they pay extra and see their due date pushed ahead. They assume it means their extra payment amounts were not applied to principal but instead to future interest. The fact of the matter is that you cannot pay interest that hasn’t accrued yet and the loan holder may not hold payments until interest accrues. This means that regardless of whether your due date is pushed ahead or not, your payment will be applied to interest in exactly the same way. So, unless you are pursuing Public Service Loan Forgiveness, there’s usually no harm in letting the due date get pushed up when making extra payments.