In the eyes of student loan lenders, some borrowers are far more profitable than others.
As borrowers, if our lenders are making huge profits, it is usually a sign that we are doing something wrong. These mistakes are often both expensive and easy to avoid.
Mistake #1: Only Paying the Minimum
In some cases, paying the minimum makes sense. If you have a 2 or 3% interest rate, there isn’t much of a rush to pay things off. Similarly, if minimum payments on one loan are part of a larger aggressive repayment strategy, minimum payments can be a smart move.
However, borrowers who just pay the minimum on all of their student loans are a lender’s dream. By only making minimum payments, these borrowers maximize total interest spending. The smaller the payment, the smaller the amount that pays down the principal balance. Lenders want payments to count towards interest because it is how they make profits. Borrowers want payments to count towards the principal because it reduces the amount they owe.
The larger the payment, the faster the debt is eliminated, and the sooner the lender profits end.
Mistake #2: Occasionally Missing Payments
Borrowers who miss deadlines from time to time are a lender’s dream come true. Each missed payment is an opportunity to charge a late fee. Missing payments also means more interest accumulates. These unnecessary expenses can help make a loan extremely profitable.
Mistake #3: Borrowers Who Use Forbearances and Deferments
Lenders like to portray a deferment or a forbearance as a favor that they extend to borrowers. Consumers should understand that these moves are also an opportunity for the lender to make more money.
By not making payments, borrowers on forbearances and deferments allow their balance to grow. This means more interest to repay. The interest also compounds. That means the interest that doesn’t get paid this month generates even more interest next month.
At some point, borrowers will have to enter repayment for the loan to be profitable, so lenders don’t let forbearances and deferments go on forever. However, for short periods, they are usually glad to allow a borrower run up their balance.
Mistake #4: Passing on Refinance Opportunities
As students, we pose a substantial credit risk to lenders. We don’t have a job, and we don’t have a degree. These limitations mean higher interest rates. As graduates with a job, a degree, and a decent credit score, we are much less of a credit risk.
Smart borrowers take advantage of their status as employed graduates and find lenders to refinance their student loans at a lower interest rate. These borrowers get the new lender to pay off their old loans in full and then repay the new lender according to more favorable terms.
Lenders prefer that their low-risk borrowers continue to repay their loans with high-risk interest rates.
Bottom Line: Avoid the Expensive Traps
Repaying student loans can be a pain. Often it feels like a war with your lender. Borrowers who set out to minimize lender profits will find that they dramatically improve their personal finances.