Like any other debt obligation, student loans come with additional interest payments. As a result, debtors end up paying more than what they originally borrowed. Sure, this process is understandable, but in the case of high-interest loans, the process can be exhausting. Luckily, you can make principal-only payments to reduce your interest payments. Paying principal on student loans can reduce the principal balance. As interest payments are some percentages of the original debt balance, reduced principal leads to lower monthly obligations.
However, there still exist conditions that you should consider before making principal-only payments. This guide discusses how to make principal-only payments on student loans effectively. If this strategy is not accessible to you, we also share some alternatives to save money from interests.
How do Monthly Payments Work?
When you get a loan, it covers the original debt balance (principal amount) and additional interest payments. Once repayment starts, you are required to make monthly minimum payments to pay off your debt in the long run. Usually, the minimum payment goes toward the principal balance and the interest (including other fees). In short, your regular payments mainly cover both the principal and interest amount.
Paying Principal on Student Loans
Besides making monthly minimum payments, you can begin paying principal on student loans. This payment covers only the principal balance and decreases this amount. As interest payments are percentages of the principal balance, you get lower interest payments for the following months. In short, if you make principal-only payments, you will pay less interest over the repayment period and save money.
When Is It Good to Pay the Principal?
If you think paying principal on student loans is suitable for you, think twice before choosing this strategy. There exist some conditions that make principal-only payments attractive for your student loans. Here are some of these conditions:
You cannot choose to only pay the principal on student loans. As mentioned, you should make minimum payments each month, and on top of that, you can pay extra for the principal. Sure, not everyone is capable of affording such an amount, considering that millions of borrowers struggle with minimum payments.
However, if you even get a one-time bonus from work, you can ask the lender to apply this payment to the principal balance. Alternatively, if you are promoted, you can use your extra income for paying principal on student loans.
Before you ask for paying principal on student loans, you should consider that it will shorten your repayment period. Although it is an attractive idea to get rid of debt obligations fast, some borrowers might not want it. For example, if a borrower seeks to qualify for the Public Service Loan Forgiveness program, they should make 120 qualifying payments.
So, it takes at least ten years to get forgiveness. If such borrowers make more payments, they might not make the required number of payments to qualify for the debt cancellation program. Alternatively, borrowers in Income-driven repayment plans can get cancellation once they complete the repayment period (20-25 years). In case debtors pay the principal on student loans every month, they might not benefit from the loan forgiveness.
Lastly, you might wish to save money from interest payments. In this case, paying principal on student loans can be effective. However, keep in mind that it is not the only strategy to save money. If you struggle with interest payments, you can also refinance your student loans with better terms. For example, in case you get a refinancing loan with a lower interest rate, you will save money. We will discuss student loan refinancing in the following sections.
Your Rights on Paying Principal Balance
The Consumer Financial Protection Bureau notes that all student loan borrowers can decide how long it will take for them to repay the debt. It means you have a right to make principal-only payments and shorten the repayment period. However, in some cases, paying principal on student loans can be challenging. Some lenders might resist this decision by redisclosure of alternative methods. During redisclosure, the borrower’s monthly payments are reset, and the repayment period gets longer. Such a situation can happen when the lender sells your loan to another lender.
Yet, keep in mind that you can still make principal-only payments even in the case of redisclosure. The law prohibits penalizing borrowers for prepayments. You can also contact your loan servicer and choose which loan you want for principal-only payments to apply. For example, if you have multiple loans, you might want to pay the principal on student loans with the highest interest levels.
How to Pay Principal on Student Loans?
Usually, loan servicers or lenders have specific online platforms to make monthly payments. In some cases, you can make your extra payments for principal-payment on these platforms. You should first put the total amount you want to pay and then state how you want your additional payment to be treated.
For example, you can let the loan servicer consider the excess amount for the following month’s payment or reduce the principal balance. In some other cases, you will not know how to pay the principal on student loans on the online platform. Some lenders cannot be requested through online platforms, and you should contact them.
Regardless of the method, the most important thing is giving clear instructions to the loan servicer’s customer representative. They should know exactly how to treat your excess payment. If you do not clarify that your aim is paying principal on student loans, they might not do it and consider extra balance for the next month. Therefore, you will not reduce the principal balance and save money from interest.
Besides clearly instructing your loan servicer/lender, it is still a good idea not to make principal-only payments during the time when you are required to pay a monthly minimum amount. In this way, the loan servicer is less likely to be confused about applying the payment.
Additionally, when you contact your loan servicer or lender, try to do it in a written way ( such as by email). Alternatively, at least ask for a confirmation email to have a proof for future problems.
It is also recommended to check your account at least once a month. In this way, you can monitor how payments are applied and if your principal balance is decreased. In addition, you can set alerts for changes, like when you make a payment, or it is the due date for the monthly minimum amount.
It is necessary to understand interest accruals and how they work when you want to benefit from principal-only payments.
Interest accruals work differently depending on the loan type. For example, if you have a Direct subsidized loan, the government covers interest payments when you are still enrolled in school. However, in the case of an unsubsidized loan, your interest payments will accrue when you study. If you do not pay these interests during school, they will accumulate. As a result, the accrued amount is added to the original debt balance when repayment starts. This process is called capitalization.
Considering that the interest payments are percentages of the original balance, increasing the principal debt amount is not desirable. Hence, it is better to avoid accrued interest.
Capitalization also applies to federal PLUS loans. However, if you have private loans, the conditions can be different. Each lender has its repayment requirements. Usually, interest is immediately required, and it starts accruing once the repayment begins.
Interest Payments during School
As mentioned before, paying principal on student loans, even in small amounts, can decrease the principal balance and interest payments. However, an alternative way can be making payments during studying. Sure, if you have subsidized loans, your interest does not accrue and increases your principal balance.
Yet, in the case of private student loans, unsubsidized, or PLUS loans, the interest payments can accrue and make your principal balance larger. Hence, it is also advisable to make interest payments while studying. In this way, you will not get accrued interest and capitalization on your balance.
Common Mistakes in Principal-Only Payments
We shared the main idea of paying principal on student loans. However, this section highlights the main mistakes in principal-only payments and repeats the basic reasoning mentioned above.
Not Tracking Payments
Sometimes borrowers have clear plans on how they will repay the debt. They aim to maintain minimum payments and make excess payments to reduce the principal balance. However, after some time, they see no progress when they check the balance. Later, they identified that the loan servicer applied extra payments to different fees, interests, and monthly payments, instead of the principal balance.
To sum up, after you make payments, preferably each month, you should check your account. You need to ensure that your loan servicer applied for payments correctly and your principal balance is decreasing. Do not rely on a loan servicer or lender solely for paying principal on student loans.
Not Considering Capitalization
Usually, borrowers get student loans while they still study. During this period, the borrowers are not so attentive about their obligations and can ignore the debt burden. Once the repayment starts, they realize that interest payments accrued and their principal balance is higher than ever -the process called capitalization.
However, if borrowers read the terms on time, they would know that any unpaid interest during studying will be capitalized. In turn, they could avoid this mistake by making interest-only payments.
Unfortunately, the capitalization process will increase your principal balance. As your monthly payments are determined based on principal debt, they can increase under such conditions.
Paying Principal on Wrong Loan
You might have multiple loans with different interest rates. In general, it is advisable to pay an excessive amount for loans with the highest interest rate. In this way, you save the most money from interest. However, some borrowers fail to inform the loan servicer on which loan they want to apply for the additional amount.
In other cases, borrowers first want to get rid of the smallest debt; a method called snowballing. Sure, getting rid of some small obligations is psychologically rewarding. Yet, the debtors do not necessarily save significant money with this strategy. Hence, it is advisable to ask your lender or loan servicer to apply extra money for paying principal on student loans with the highest interest level.
Student Loan Refinancing
Paying principal on student loans helps borrowers save money from interest payments. However, not all borrowers have excess money to make principal-only payments. In this case, you can benefit from student loan refinancing.
Student loan refinancing is an alternative way to reduce loan interest and save money. The borrowers can get refinancing loans and use the funds to pay off their existing loans. This way, they can get rid of the current loans with higher interest rates. However, you need to get a lower-interest refinancing loan if you want this strategy to work.
If utilized correctly, refinancing can reduce monthly payments, help you save money, change your lender or payment type. Some lenders or loan servicers are pressuring the borrowers for repayment. If you are fed up with them, you can refinance the loan. As a result, you pay off the debt to the annoying lender and get a new loan servicer.
Besides, refinancing allows borrowers to change variable-rate loans to fixed loans or vice versa.
Why Refinancing Works?
You might wonder how you would qualify for a lower interest rate. Most borrowers get loans when they are still students. This case is specifically applicable to private loan borrowers who do not have good credit performance and low to no income. Hence, these debtors only qualify for high-interest loans. Over time, their credit performance increases, and they find well-paid jobs. Instead of continuing repayment with high-interest loans, such borrowers can refinance debt to lower interest rates.
An alternative situation happens if market conditions change. Sometimes, market interest rates can decrease depending on the economic factors, and loans can become cheaper. In this case, refinancing is beneficial.
All these conditions act have similar consequences to paying principal on student loans because they decrease the interest payments. Therefore, you save money in the long run.
Refinancing: Private vs. Federal Loans
Before you decide to refinance a student loan, you should think carefully. Refinancing is significant for private student borrowers if they can decrease interest. However, for federal loan borrowers, refinancing has some drawbacks. If you refinance, you can lose eligibility to federal student aid benefits, like loan forbearance, enrollment to Income-driven repayment plans, or forgiveness programs. Refinancing might seem less beneficial compared to affordable rates of Income-driven plans or loan cancellation opportunities through forgiveness programs.
If paying principal on student loans is hard, you can refinance a student loan to save money. Refinancing requires a good credit score, stable income, and a co-signer. You need to have 650 or more credit to qualify for low-interest refinancing loans. Besides, a co-signer can be required. The co-signer should have the same qualifications and agree to repay the debt if borrowers cannot.
When you get funding through student loans, you repay the debt together with its principal and interest payments. Unfortunately, high-interest loans lead to higher monthly payments, usually not affordable for millions of borrowers. Therefore, paying principal on student loans can be a good strategy because it decreases the principal balance on which interest payments are calculated. In short, you can save money by making principal-only payments. This guide discussed making principal-only payments on student loans and gave some valuable tips if you consider this option. However, if this strategy is not accessible to you (if you earn less and have no extra money), you can also benefit from student loan refinancing.