Getting Student Loan Payments to Count Towards Principal and Not Interest

Michael Lux Blog, hacks, Student Loans 0 Comments

One of the most frustrating aspects of student loan debt is that interest eats up large portions of your monthly payment.  Interest can be so bad that in some cases the monthly interest is larger than the monthly payment.  Borrowers in this circumstance make their monthly payment, but they continue to watch their student loan balance grow.

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 the student loans.

Interest typically accrues on a daily basis.  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.  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

There are several different tactics that 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:

  1. Fees and penalties
  2. Interest
  3. Principal

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 pay 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, 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 are able to get a lower interest rate it means that your debt will generate less interest each month.  By doing this, larger portions of your payment will reduce the principal 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 actually 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.  They cannot just count the extra payment as interest.  What they can do is spread the payment out towards all of your student loans.  This is not what you want your lender to do.  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.

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.

Bottom Line

Seeing the majority of your student loan payment go to lender profits instead of reducing what you owe can be terribly frustrating.  The good news is that there are a number of strategies that can be used to make your money go further towards attacking your debt.

Once you understand the lender strategies to maximize profits, you can avoid traps and pay off your student loans as quickly as possible.