One of the biggest perks of the new SAVE repayment plan is the generous interest subsidy available to borrowers.
For borrowers who qualify for $0 per month payments, it means their student loan is essentially interest-free during this time.
I’ve heard from many borrowers who want to maximize this subsidy and pay down their loans as quickly as possible. Guidance here is especially complicated because the Department of Education has altered the guidance that it gives borrowers who receive the subsidy. Arguably, there is a policy change at play here.
Thus, we need to cover three different situations:
- What is the rule if you make extra payments while on the SAVE plan?
- Has this rule changed?
- If you made extra payments based on bad guidance from the Department of Education, what is your remedy?
How do I know if I get a SAVE subsidy? If you don’t want to do any math, this calculator will provide SAVE payments and monthly subsidy amounts.
If you want to do the math on your own, it is pretty simple. For each loan, multiply the balance by the interest rate. This number will give you the yearly interest charges on the loan. Divide that number by 12 to estimate the monthly interest charges for that loan. You get a subsidy by the amount your monthly interest charges exceed your monthly payment.
How Servicers Process Extra Payments for Borrowers who Receive the SAVE Interest Subsidy
If you look at the current version of the Department of Education’s page on SAVE, there isn’t much clarity about how extra payments are processed.
In theory, borrowers could use the subsidy to cover their unpaid interest, and then make an extra payment to lower their principal balance. The SAVE page doesn’t advise against making extra payments.
Unfortunately, the way it works isn’t very favorable to borrowers.
To find clarity on this situation. I spoke with someone from the ombudsman office at a loan servicer. Because the servicers are responsible for processing payments, they have to know how to apply extra payments and whether or not it will reduce the principal balance or the interest.
I was told that the SAVE subsidy is applied on a one month delay. When applying the subsidy, they compare payments against interest charges for the previous month. If the interest charges are greater, the borrower gets a subsidy in that amount.
This means that the borrowers who pay extra reduce their subsidy. It also means paying extra while recieving the SAVE subsidy is a big mistake.
Confusion About Subsidy Application and Strategy
When the SAVE Subsidy was first announced, it looked like borrowers were able to make extra payments and have 100% of the extra payments count toward principal.
The Department of Education recommended that borrowers pay extra to lower their balance, even if they qualify for $0 payments on SAVE:
The above language comes from an archived version of the SAVE announcement.
Notably, this language has been removed from the SAVE page.
Sherpa Thought: Between the servicer clarifications I’ve received and the language removal from studentaid.gov, it seems quite clear to me that extra payments on SAVE will first reduce the interest balance before being credited toward the principal balance.
It is possible that the Department of Education changes this policy, but for now, making extra payments if you recived the SAVE subsidy is a mistake.
Refunds for Previous Extra Payments
If you previously made extra payments in an attempt to have 100% of that extra payment count toward your principal balance, I think you should get a refund on that extra payment.
There isn’t currently a Department of Education policy that makes issuing refunds easily available, but a refund would fix things for borrowers who followed the guidance posted to studentaid.gov.
If you want to take action to get a refund on your previous extra payments, I’d suggest the following:
- Ask your servicer for a refund. Explain that you followed the advice of the Department of Education. This request will likely be denied.
- File a complaint with the Consumer Financial Protection Bureau. Once again, explain that you made extra payments to lower your principal balance and instead it reduced your subsidy. Filing a complaint with the CFPB is relatively easy, and if enough people do it, it makes a difference.
- Contact your elected officials. All members of Congress have staff members dedicated to helping voters navigate federal programs and red tape. Correcting an issue for a borrower who was misled by the Department of Education is exactly the sort of thing they can help with.
If you’d like help with any of the above steps or you want to share your progress, please send me a quick email. Student loan repayment is far too complicated, and when the Department of Education gives bad advice, borrowers deserve to get it corrected.
Making the Most of the Interest Subsidy
If you do receive the interest subsidy, it is still possible to set aside “extra payments” to attack your student debt.
My suggestion is to open a dedicated high-yield savings account for this money. Each month you earn interest on the money you have set aside. Meanwhile, the subsidy covers some or all of the interest charges on your student loans. It is a rare win-win for borrowers.
Sherpa Transparency: This page once linked to and quoted the now-deleted language from the Department of Education.
Readers were told that even though their extra payments would count toward principal, they were advised not to follow the Department of Education guidance and to utilize the high-interest savings account instead.
Perks of Minimum Payments and Maximum Subsidy
Even if your savings account paid 0% interest, there are still some significant advantages to putting the extra payments into a savings account.
Build Up an Emergency Fund
When you have lots of student debt, building up an emergency fund may seem like a luxury, but in reality, it is a necessity.
Having money set aside for your federal loans doesn’t mean you must use it for your federal loans. For the borrowers who lack self-control, this can be a significant issue. For others, it is a great asset.
Putting money in savings rather than making a student loan payment means you can pay for an unexpected car repair or medical emergency. If that money was used to pay down your student debt, it is gone forever.
Ideally, you can earn money on interest and then make a large lump sum payment to knock out the loan. If the unexpected happens, you have some flexibility.
Keep the Door Open to Forgiveness
Typically, borrowers employ one of two strategies to eliminate their student debt. They can either make minimum payments and hope to get as much forgiven as possible, or they can aggressively repay their debt to spend as little as possible on interest.
By utilizing the interest subsidy and a high-yield savings account, borrowers can put money aside for aggressive repayment and make minimum payments toward forgiveness.
If your finances change and aggressive repayment becomes the obvious choice, you have money to attack the loan. If you realize that forgiveness is the ideal approach, you will be glad you didn’t make extra unnecessary payments on the loan.
Final Thoughts on the SAVE Interest Subsidy Confusion
When something like this happens, many people are quick to accuse the Department of Education or loan servicers of intentionally misleading borrowers.
I don’t think that is the case here.
At the time the Department of Education posted the now-deleted tip, the SAVE repayment plan was brand new and the exact process for handling the payments may not have been finalized.
That said, even if the error wasn’t malicious, it should still get corrected. All SAVE borrowers who made extra payments following the Department of Education tip should either receive a refund on their extra payment or have the principal balance credited accordingly.
So if, for example, my required payment on SAVE is $0, but my loan balance generates $300 in interest each month. Let’s say I decide to make a $500 payment outside of the regular payment schedule. Would the $500 go directly to the principal balance? Or would the first $300 go towards the interest until the accrued interest was entirely paid, before anything goes towards the principal?
It should be applied entirely to principal (though you will want to make sure your servicer applies the payment correctly). That said, I’ve not really seen many cases where it makes sense to pay extra when you are receiving the subsidy. You can always just put that extra payment in a high yield savings account. Then you earn some interest with the money and when it is large enought to pay off the loan, or you no longer qualify for a subsidy, you can make a large payment.