Help! My Student loan payments don’t even touch the principal balance

Michael Lux Blog, Student Loans 0 Comments

Making payments on student loans can be brutal.  For many it is a struggle just to set aside the money each month to make the minimum payment.  The really deflating part comes when you realize that only a small portion of that payment actually reduces the student loan balance.  A $150 payment might only reduce your principal balance by $10 or $20.  As a result, repayment lingers on and on, seemingly forever.

Avoiding this issue is a problem that has tripped up many student loan borrowers.  Fortunately, there are several different methods to attack the loan balance so that the debt doesn’t last forever.

Understanding the Issue

Before you can attack the problem, step number one is to understand how it works.  In student loan repayment, lenders first collect fees, then interest, and only then does your monthly payment actually reduce your balance.  Because of this system, lenders have a huge incentive to nickel and dime you in any way they can.  Late fees are pure profit to lenders.  Interest collected is also profit.  The more interest a lender can collect over the life of the loan, the more profitable the loan becomes.  This is why lenders are normally so generous when it comes to in school deferrals and grace periods after graduation.  The interest is growing that balance on a daily basis.  It is only when the lender fears you might be struggling to pay back that loan that they become stingy on deferments.

Two factors drive up the percentage of payment that goes towards interest.  The first factor is the interest rate.  Higher interest rates mean a smaller portion of your monthly payment actually pays off the debt.  The other factor is the repayment length.  If you are on a 30 year repayment plan, it will result in lower payments, but only a small portion of those payments actually reduces the principal balance.  If you were on a five-year repayment plan, a much bigger chuck of the payment would have to attack the principal each month.

What can I do?

There are three basic strategies to make sure that more of your payment goes towards the principal balance.  If you are able to use any of these three strategies, you will get your loan paid off faster.

Option One: Lender Assistance

Unfortunately this option only is available to a small group of people.  If you are struggling to keep up with your payments and your lender is willing, you can qualify for a rate reduction.  The most common example of this is Navient’s Rate Reduction Program.  Struggling borrowers can have their interest rates reduced to 3% or lower in order to stay caught up on their student loans.  The interest rate reduction lasts only for a year, but it can be renewed so long as there is still a financial need.  The nice part about this program is that it reduces your monthly payments and lowers the interest spent.  Rarely do we get to spend less and get more.  However, this program is limited to those with serious financial hardships, so many people will not qualify.

Option Two: Find a New Lender

If option one was for those who were struggling, option two is for those on the other end of the spectrum.  Over the past five years the student loan consolidation and refinancing marketplace has become incredibly competitive.  Lenders have recognized that some graduates are very likely to pay back their loan.  Less risk means lower interest rates.  Common examples of lenders in this business would be LendKey and SoFi.  Both lenders offer interest rates starting around 2%, and they even give new borrowers cash bonuses of $100 with LendKey and up to $150 with SoFi.

This process pays off your old loan entirely and replaces it with a brand new loan.  The idea behind it is lower interest rates, but it also means giving up the terms of your previous loan.  If it was a federal loan with borrower protections such as income driven repayment or student loan forgiveness, it is important that you make sure you are making a smart move.  If you just need a lower interest rate it can be a huge win, but if you might need federal protections in the future, it could be a big mistake.

Option Three: Attack!

This is probably the least appealing option, but it is also the option that everyone can do.  Every extra penny you apply towards your student loans goes directly to the principal balance.  While a few extra bucks a month may not seem like much, it can take months or even years off your repayment length.

A few months ago we suggested a repayment strategy that would cost a couple extra bucks each month but would pay off your loan in half the time.  The Sherpa Plan for Aggressive Repayment essentially calls for payment of double what normally goes towards the principal balance.  So if you are paying $150 per month, and only $20 goes towards principal, you pay $170 per month.  As the percentage that is applied to principal increases, you increase your payment.  The nice part about this approach is that you can ease your way into aggressive student loan payment and it encourages you to keep a close eye on your debt.  The downside is that it does require a little bit of math each month.

Other borrowers simply choose to put whatever extra money they have towards their student loans.  Without question, this is the way to pay off the debt as fast as possible.  Start with your highest interest debt, and work your way down.  With interest being the enemy, paying off high interest loans is the preferred approach.

Bottom Line

There is no one size fits all approach to eliminating debt.  For some, a combination of these strategies may be the ideal route.  However, no matter what your situation, there are ways to make sure that your payments go towards actually reducing your loan balance instead of lining your lenders pockets.  Just keep reminding yourself: interest is the enemy and every little bit helps.  Before you know it, your loan will be history.