What looks like a bill, sounds like a bill, and smells like a bill, but really isn’t a bill?
The answer to this horrible riddle is a Federal Student Loan Interest Notice.
Fedloan Servicing and other federal student loan servicers send out these Interest Notices at the end of most students’ grace period. The Interest Notice lists the “Total Outstanding Interest” and a “Pay By” date. At the bottom of the page there is even a payment ticket pre-addressed to the loan servicer.
The entirety of the document makes the “This is not a bill” language in the middle rather confusing. If it is not a bill why is there an amount due and a deadline?
Federal Student Loan Interest Notice
To make sense of this confusion, we need to briefly cover to topic of interest capitalization.
Interest capitalization occurs when the interest that a loan generates is added to the principal balance. In other words, when student loan interest is capitalized, borrowers start paying interest on the interest.
Example:Suppose a borrower has $1,000 in federal student loans at 5% interest. After a year, that $1,000 loan will have generated about $50 in student loan interest.
When the interest is capitalized, the borrower’s new balance becomes $1,050. Going forward that borrower is charged interest on a $1,050 loan instead of a $1,000 loan.
As balances get larger, capitalized interest quickly becomes very expensive.
The purpose of the Interest Notice that is mailed out is to alert borrowers that their student loan balance is about to go up. The “Total Outstanding Interest” will be added to the student loan balance if a payment is not made.
In short, the borrower does have a deadline, but they don’t actually have to make a payment.
What Happens If I Don’t Make The Payment?
Borrowers who do not make payments based upon the interest notice will not run into any late fees, nor will there be any negative credit reporting. After all, the interest notice is not a bill.
What will happen is that their student loan balance will go up and that larger balance will generate more interest each month. This cycle of balances growing because of interest, then generating even more interest, is how some borrowers get into trouble with student debt. Those who are not careful may see their debt spiral out of control if they do nothing once repayment starts.
Paying the interest that accrued would be great, but many borrowers cannot afford to pay off all of the interest and many more choose not to make the payment.
The important thing for borrowers to understand that repayment is about to begin, and they should have a plan…
Getting Ready for the First Real Bill
The interest notice should serve as a reminder to all borrowers that the bills are about to start coming. The next federal student loan envelope will likely contain a real bill.
Borrowers who haven’t enrolled in any repayment plan are automatically signed up for the 10-year standard repayment plan. This happens to be the repayment plan with the highest monthly payments.
The Department of Education has a very useful tool called the Repayment Estimator. Using the Repayment Estimator, borrowers can get a good idea of what their monthly payments will look like on the many federal repayment plans.
Generally speaking, we suggest borrowers opt for the plan with the lowest monthly payments so that they can focus on quickly paying off the student loan with the highest interest rate. This is the most efficient method of repayment, but it depends upon the borrower having the self discipline to make the extra payments each month.
There are many different strategies that go into selecting the best federal repayment plan, but all federal borrowers should give careful consideration to the route that best fits their needs.
When that Interest Notice appears it can be scary, but because it isn’t actually a huge bill, it isn’t that big of a problem.
However, student loan debt is still going to be a problem. The Interest Notice can be ignored, but the student debt behind it cannot.
Borrowers would be wise to turn the fear and anxiety from receiving the notice into research and effort into eliminating their student loans.