One of the most frustrating aspects of student loan debt is that interest eats up large portions of your monthly payment, while very little lowers the principal balance.
Interest can be so bad that in some cases, the monthly interest is larger than the monthly payment. Borrowers facing high interest rates may never miss a payment and spend thousands of dollars over the years and only see their balance drop by a few hundred dollars.
Lenders have a huge incentive to count payments towards interest because interest is how these companies generate income. However, borrowers have options that can make a larger percentage of their payment count towards the principal balance.
With less money applied to interest, student debt can be eliminated faster. In many cases, a smart strategy can make a big difference for debt elimination… even if you don’t have extra cash to spare.
Battling Student Loan Interest
Unfortunately, student loan interest is a reality in all student loans. It is how lenders and the federal government make money on student loans.
Interest typically accrues daily. With most private student loans, this accrued interest is typically added to your balance once a month.
There is no way to avoid student loan interest completely. However, there are ways to minimize interest and make sure a larger portion of your student loan payment attacks your principal balance.
Payments targeting the principal balance
Several different tactics can be used to knock down your principal balance.
Avoid Late Fees and Lender Charges – If your lender charges you a late fee or any other fee, this money becomes lender profits and does not touch your principal balance. When lenders receive a monthly payment, they usually pay down balances in the following order of priority:
- Fees and penalties
It is important to remember that fees and interest are lender profits, while a reduction of the principal balance lowers the amount that you owe. Expect most lenders to charge fees and interest whenever possible. Making sure that you do not miss any deadlines or incur other fees is essential.
Pay a little bit extra each month – This method can be an incredibly effective method to eliminate debt. We have previously shown how as little as $10 per month can actually make a huge difference in paying off your student loans. This approach helps on two fronts. First, the extra money you pay should be applied directly to your principal balance. Thus, the more you pay, the larger percentage of your monthly payment reduces your balance. Second, as your principal balance decreases, the monthly interest charge will also go down. That means the extra payment you make lowers your balance immediately, and it makes a larger percentage of every future payment count towards principal.
Take your business elsewhere – All lenders charge interest, but not all lenders charge the same interest rate. If you have a decent job and your lender is charging you 6, 8 or 10% on your student loans, the odds are pretty good that you can get a lower interest rate elsewhere. This is because you are much less of a credit risk as an employed college graduate than you were as an unemployed college student. Less credit risk equals a lower interest rate. There are over a dozen lenders offering student loan refinancing services.
If you can get a lower interest rate, it means that your debt will generate less interest each month. By doing this, more substantial portions of your payment will reduce the principal balance. In short, the same exact payment could put a much bigger dent in your debt balance.
Ask your lender for help – This approach is a long shot, but if you are in a desperate situation, it can potentially work. The key is to understand the lender tricks that hurt, and the things lenders can do that might actually help.
Lenders are usually happy to offer a forbearance or a deferment on your student loan. This means you don’t have a bill for a few months, but it is making your student situation much worse. Even though payments stop, the monthly interest does not. Your balance after a forbearance or deferment will be much larger than what it was when it started. Along the same lines, if your lender lowers your payment, but not your interest rate, it just means you will pay more money on interest over the life of the loan.
The thing that can help is if your lender is willing to temporarily lower the interest rates on your student loans due to a hardship. We have seen some borrowers have some success with this approach. If you are truly struggling to repay your loans and your lender will not work with you, consider filing a complaint with the Consumer Financial Protection Bureau. These complaints can force your lender to take a second look at your situation and potentially get you the result you seek.
Be sure to pick the right principal balance
If you do pay extra towards your student loans, lenders apply the extra payment in different ways. Some use the payment to lower the bill for furture payments. Others spread the extra payment across all of your loans.
Borrowers get to specify how they want additional payments processed. Have your lender put all of your extra payments towards one of your student loans. Target the student loan with the highest interest rate. Using this strategy, you will most efficiently reduce future spending on interest.
A common mistake that many borrowers make is to pay a little extra on all of their student loans. While this approach is better than just paying the minimum, it still can cost thousands of dollars due to its inefficiency.
Some lenders will also reduce the amount you owe on future payments. If you pay a double payment this month, they may say you don’t owe anything next month. Don’t fall into this trap. Lender profits are maximized when you pay the minimum. They do this to encourage you to pay less now so that they get more interest in the future.
Student loan interest vs. principal
Seeing the majority of your student loan payment go to lender profits instead of reducing what you owe can be terribly frustrating. Proactive borrowers can usually find ways to save money on interest without having to spend anything extra.
Once you understand the lender strategies to maximize profits, you can avoid traps and pay off your student loans as quickly as possible.