Student loans can be intimidating. There are so many technical terms you need to learn in order to maximize your repayment strategy — stuff like IBR, REPAYE, above-the-line deduction and student loan amortization.
Let’s tackle that last one, shall we? Exactly what is student loan amortization and how does it affect your monthly payments?
What is student loan amortization?
To understand student loan amortization, let’s start with a brief overview of loans. There are two types:
The first is a revolving loan, like a credit card. With a revolving loan, you have a line of credit for a particular amount (let’s say $1,000) that you can borrow from again and again. Your monthly payment depends on how much of that amount you’ve currently borrowed. As long as you don’t exceed the limit and make at least the monthly payment, you can borrow the same money many times.
The second type of loan is an installment loan, which includes mortgages, auto loans and student loans. This is a loan you borrow once, and then gradually pay back over time. Generally, these loans have a fixed monthly payment — part of that payment goes to principal, and a certain amount to interest.
Amortization refers to the process of paying back an installment loan on a fixed payment schedule. Unlike a revolving loan, you can’t “re-borrow” money you’ve paid back, but your monthly payment amount under an installment loan won’t fluctuate the way it can under a revolving loan, either.
Are my student loans amortized?
Now that you have a clear definition of student loan amortization, you probably want to confirm whether your student loans have amortized or not. As you see above, since amortization applies to installment loans, and your student loan falls into that loan category, your loans have amortized.
How amortization affects your monthly student loan payment
Perhaps counterintuitively, even though your payment under a typical installment loan is the same each month, the amount of your monthly payment allocated to principal and interest changes over the life of the loan.
Almost always, more of your monthly payment goes toward interest during the early years of repayment. Below is a table of my own student loan payments from 2013. Notice how almost all of my payment went toward interest until I started paying extra in August:
|Payment Date||Minimum Payment||Actual Payment||Principal Paydown||Interest Charged|
You can see that despite paying over $3,300 toward that loan over the course of the year, I only reduced my balance by about $700 — and that’s only because I started making extra payments.
Since the balance on that loan was over $55,000, that was pretty tough to swallow. So if you just started making student loan payments, you could be paying hundreds of dollars a month only to see your balance decrease by a fraction of that amount. Frustrating!
Amortization and income-driven repayment
Under certain repayment plans, especially income-driven plans like IBR, PAYE and REPAYE, your monthly payment isn’t fixed — it varies according to your income.
However, the amount of interest you’re being charged doesn’t vary. This can lead to a situation where your monthly payment not only doesn’t pay off any principal at all, it doesn’t even cover the interest due. This is called “negative amortization.”
Watching your balance grow because of negative amortization can be disheartening, but it’s worth it in the long run if you’re holding out for loan forgiveness. Just remember that if you leave an income-driven plan, your interest may be capitalized (added to your principal balance). When that happens, you are paying interest on your interest.
You can make extra payments, though, even if you are on an income-driven plan, which helps avoid negative amortization.
How to get the upper hand with student loan amortization
Amortization can’t be avoided entirely, since it’s how all installment loans work. However, if you are strategic about your repayment plan, you can maximize the amount that goes toward the principal and start to make a bigger dent in your balance.
Whether you are dealing with negative amortization or regular, run-of-the-mill amortization, the best way to reduce the amount of interest you are being charged is to pay extra toward your student loans — as much as you can, as often as you can.
Here are some things to keep in mind when making extra payments:
1. Make extra payments according to the ‘debt avalanche’ method
Under this method, you pay the minimum on all balances except the one with the highest interest rate. Any money you have left over in your budget for extra payments, as well as any surprise windfalls, should be directed to that highest-interest balance.
Because your extra payments will be directed toward principal, and because the amount of interest you are charged is based on your principal balance, the debt avalanche method is the best method for reducing the amount of interest you pay over the lifetime of the loan.
Check out this prepayment calculator to see the impact it could have on your loans.
2. Make it explicit that extra payments are for the principal, not the interest
Sometimes loan servicers will apply extra payments toward the next month’s payment (read: next month’s interest) instead of toward principal. Additionally, if you have multiple loans with one servicer, they may also apply the extra payment to a loan of their choosing rather than the one you’re targeting.
Include a note in the appropriate field of your online payment or physical check, then double-check that your payment was applied as directed and contact your servicer for a correction if necessary.
3. Refinance at a lower interest rate
The lower your interest rate, the more of your monthly payment goes toward principal, and the faster you pay back your loans — even during months when you can’t make extra payments for one reason or another.
Be careful when refinancing, however. If you currently have federal loans, for example, you could be giving up benefits like access to deferment, forbearance or income-driven repayment options should you refinance with a private lender.
On the other hand, with some refinancing lenders offering very competitive rates, the money you save could be used to help you get out of debt faster.
Amortization isn’t your friend, but it can be conquered!
While there’s nothing fun about seeing part of your hard-earned student loan payments going toward interest, understanding the process can make it less scary.
And once you’re operating from a place of logic and knowledge rather than fear, you’re in a better position to strategize the best way to put student loan amortization — and student loan debt as a whole — behind you, once and for all.
Kristina Byas contributed to this report.
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1 Important Disclosures for Earnest.
To qualify, you must be a U.S. citizen or possess a 10-year (non-conditional) Permanent Resident Card, reside in a state Earnest lends in, and satisfy our minimum eligibility criteria. You may find more information on loan eligibility here: https://www.earnest.com/eligibility. Not all applicants will be approved for a loan, and not all applicants will qualify for the lowest rate. Approval and interest rate depend on the review of a complete application.
Earnest fixed rate loan rates range from 2.98% APR (with Auto Pay) to 5.79% APR (with Auto Pay). Variable rate loan rates range from 1.99% APR (with Auto Pay) to 5.64% APR (with Auto Pay). For variable rate loans, although the interest rate will vary after you are approved, the interest rate will never exceed 8.95% for loan terms 10 years or less. For loan terms of 10 years to 15 years, the interest rate will never exceed 9.95%. For loan terms over 15 years, the interest rate will never exceed 11.95% (the maximum rates for these loans). Earnest variable interest rate loans are based on a publicly available index, the one month London Interbank Offered Rate (LIBOR). Your rate will be calculated each month by adding a margin between 1.82% and 5.50% to the one month LIBOR. The rate will not increase more than once per month. Earnest rate ranges are current as of July 31, 2020, and are subject to change based on market conditions and borrower eligibility.
Auto Pay discount: If you make monthly principal and interest payments by an automatic, monthly deduction from a savings or checking account, your rate will be reduced by one quarter of one percent (0.25%) for so long as you continue to make automatic, electronic monthly payments. This benefit is suspended during periods of deferment and forbearance.
The information provided on this page is updated as of 7/31/2020. Earnest reserves the right to change, pause, or terminate product offerings at any time without notice. Earnest loans are originated by Earnest Operations LLC. California Finance Lender License 6054788. NMLS # 1204917. Earnest Operations LLC is located at 302 2nd Street, Suite 401N, San Francisco, CA 94107. Terms and Conditions apply. Visit https://www.earnest.com/terms-of-service, email us at [email protected], or call 888-601-2801 for more information on our student loan refinance product.
© 2020 Earnest LLC. All rights reserved. Earnest LLC and its subsidiaries, including Earnest Operations LLC, are not sponsored by or agencies of the United States of America.
2 Important Disclosures for Laurel Road.
Laurel Road Disclosures
All credit products are subject to credit approval.
Laurel Road began originating student loans in 2013 and has since helped thousands of professionals with undergraduate and postgraduate degrees consolidate and refinance more than $4 billion in federal and private school loans. Laurel Road also offers a suite of online graduate school loan products and personal loans that help simplify lending through customized technology and personalized service. In April 2019, Laurel Road was acquired by KeyBank, one of the nation’s largest bank-based financial services companies. Laurel Road is a brand of KeyBank National Association offering online lending products in all 50 U.S. states, Washington, D.C., and Puerto Rico. All loans are provided by KeyBank National Association, a nationally chartered bank. Member FDIC. For more information, visit www.laurelroad.com.
As used throughout these Terms & Conditions, the term “Lender” refers to KeyBank National Association and its affiliates, agents, guaranty insurers, investors, assigns, and successors in interest.
Assumptions: Repayment examples above assume a loan amount of $10,000 with repayment beginning immediately following disbursement. Repayment examples do not include the 0.25% AutoPay Discount.
Annual Percentage Rate (“APR”): This term represents the actual cost of financing to the borrower over the life of the loan expressed as a yearly rate.
Interest Rate: A simple annual rate that is applied to an unpaid balance.
Variable Rates: The current index for variable rate loans is derived from the one-month London Interbank Offered Rate (“LIBOR”) and changes in the LIBOR index may cause your monthly payment to increase. Borrowers who take out a term of 5, 7, or 10 years will have a maximum interest rate of 9%, those who take out a 15 or 20-year variable loan will have a maximum interest rate of 10%.
KEYBANK NATIONAL ASSOCIATION RESERVES THE RIGHT TO MODIFY OR DISCONTINUE PRODUCTS AND BENEFITS AT ANY TIME WITHOUT NOTICE.
This information is current as of September 9, 2020. Information and rates are subject to change without notice.
3 Important Disclosures for SoFi.
4 Important Disclosures for Splash Financial.
Splash Financial Disclosures
Terms and Conditions apply. Splash reserves the right to modify or discontinue products and benefits at any time without notice. Rates and terms are also subject to change at any time without notice. Offers are subject to credit approval. To qualify, a borrower must be a U.S. citizen or permanent resident in an eligible state and meet applicable underwriting requirements. Not all borrowers receive the lowest rate. Lowest rates are reserved for the highest qualified borrowers. If approved, your actual rate will be within a range of rates and will depend on a variety of factors, including term of loan, a responsible financial history, income and other factors. Refinancing or consolidating private and federal student loans may not be the right decision for everyone. Federal loans carry special benefits not available for loans made through Splash Financial, for example, public service loan forgiveness and economic hardship programs, fee waivers and rebates on the principal, which may not be accessible to you after you refinance. The rates displayed may include a 0.25% autopay discount.
The information you provide to us is an inquiry to determine whether we or our lenders can make a loan offer that meets your needs. If we or any of our lending partners has an available loan offer for you, you will be invited to submit a loan application to the lender for its review. We do not guarantee that you will receive any loan offers or that your loan application will be approved. Offers are subject to credit approval and are available only to U.S. citizens or permanent residents who meet applicable underwriting requirements. Not all borrowers will receive the lowest rates, which are available to the most qualified borrowers. Participating lenders, rates and terms are subject to change at any time without notice.
To check the rates and terms you qualify for, Splash Financial conducts a soft credit pull that will not affect your credit score. However, if you choose a product and continue your application, the lender will request your full credit report from one or more consumer reporting agencies, which is considered a hard credit pull and may affect your credit.
Splash Financial and our lending partners reserve the right to modify or discontinue products and benefits at any time without notice. To qualify, a borrower must be a U.S. citizen and meet our lending partner’s underwriting requirements. Lowest rates are reserved for the highest qualified borrowers. This information is current as of September 10, 2020.
5 Important Disclosures for CommonBond.
Offered terms are subject to change and state law restriction. Loans are offered by CommonBond Lending, LLC (NMLS # 1175900), NMLS Consumer Access. If you are approved for a loan, the interest rate offered will depend on your credit profile, your application, the loan term selected and will be within the ranges of rates shown. All Annual Percentage Rates (APRs) displayed assume borrowers enroll in auto pay and account for the 0.25% reduction in interest rate. All variable rates are based on a 1-month LIBOR assumption of 0.16% effective August 10, 2020.