Student loan repayment is a constant battle against interest, and the best way to beat the interest is to pay off the loan early, which means paying extra each month. One of the challenges of making extra payments is getting the lender to process the payment correctly. It seems each student loan servicer has a slightly different policy for prepayments.
Fortunately, there are only a few different ways lenders can handle accounting for extra payments. Better yet, this is one student loan situation where the borrower has significant control. Borrowers have the right to specify how prepayments are handled and how it impacts future payments.
In most cases, a quick email or call with instructions can help a borrower avoid a headache and ensure the smooth processing of extra payments.
The Federal Student Loan Prepayment Procedure
The Code of Federal Regulations specifies how federal servicers are supposed to process early payments.
When a payment is processed, funds are first used to pay off any accrued interest or fees on the loan. This is the standard procedure used by all federal and private lenders for processing payments. Borrowers cannot lower their principal balance without first paying off accrued interest and fees.
If the prepayment is larger than the monthly bill, loan servicers are required to do the following:
- Advance the due date of the next payment unless the borrower requests otherwise; and
- Notify the borrower of any revised due date for the next payment.
In other words, if you make a double payment one month, it means you won’t have to make a payment the following month. However, borrowers that want their bills to continue as planned may request to do so.
Most private lenders follow a similar procedure.
Borrower Choices for Extra Payments
Prepayments are a great opportunity for borrowers to attack their student debt strategically. Borrowers get to pick how they want the loan processed in a couple of important ways:
Future payments – Borrowers may elect to have extra payments eliminate future bills. A borrower could pay triple this month and not make payments for the next two months. From a debt elimination standpoint, the quickest approach is usually to pay extra when possible and keep making payments each month.
Loan Selection – Borrowers with multiple loans should specify which loan the extra payment should be used towards. Some lenders and servicers will automatically apply the extra payment towards the loan with the highest interest rate. Others may apply part of the extra payment towards all of the borrower’s student loans. Borrowers should specify to their lender how they want the payment processed. Most will want to target the highest interest loan, but some might select the loan with the smallest balance.
Each lender has a default policy for handling extra payments. However, borrowers can override the default policy on future payments and loan selection.
Giving Instructions to Loan Servicers and Lenders
This is one area where each student loan company is slightly different.
Some lenders have an option to specify how they want prepayments handled when they make payments online. Some lenders will look at the memo line of a check and process the payment according to the instructions given.
Most borrowers will need to send an email to their lender or place a call to find out how to give the lender instructions on prepayments. Some lenders even allow borrowers to provide instructions for all future payments. Others will need instructions for each extra payment.
Borrowers that send physical checks can specify instructions in the memo line. Like other strategies, double-checking to make sure that your servicer followed your instructions is essential.
Keep an Eye on Automatic Payments
If your lender automatically pulls money out of your account each month, these automatic payments will likely continue, even if your monthly bill is pushed back.
Likewise, if your bank automatically sends a payment each month, these monthly payments will continue whether or not you receive a bill.
Borrowers should be careful to ensure that extra payments and automated payments don’t result in an overdrawn checking account. Auto-debit systems and student loan billing systems are typically independent. These systems usually don’t adjust to a smaller bill or a skipped bill.
One of the rare perks of student loans is that lenders cannot charge prepayment penalties. This rule applies to federal and private loans.
Borrowers are permitted to pay off their student loans as fast as their finances allow.
Watching for Mistakes
Borrowers should always keep an eye on how a lender processes payments. This is especially true for borrowers making extra payments.
Because borrowers have many options for prepayments, lenders have many ways to make mistakes. Thus, borrowers should look at their accounts a few days after any extra payments are processed. Borrowers can address most errors with a phone call to their loan servicer.