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Student Loan Amortization Explained: How to Pay Off Your Debt Faster

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If you’ve been making student loan payments only to find that your balance hasn’t budged, you might be wondering if student loans are amortized.

Unfortunately, yes, student loan amortization is slowing your progress.

While there’s nothing fun about seeing a significant part of your hard-earned loan payments going toward interest rather than principal, understanding student loan amortization can make it less frustrating. Let’s start by answering these three questions:

Are student loans amortized?

To understand student loan amortization, let’s start with a brief overview of loans. There are two types:

Revolving Loan (such as 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.

Installment Loan (such as a student loan or mortgage)

  • 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.

So, are student loans amortized? As you see above, since amortization applies to installment loans, and your student loan falls into that category, your loans have amortized.

How does student loan amortization affect your monthly 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 of that year:

Payment Date Minimum Payment Actual Payment Principal Paydown Interest Charged
1/28/2013 $221.30 $221.30 $18.43 $202.87
2/28/2013 $221.30 $221.30 $0.00 $221.30
3/28/2013 $221.30 $221.30 $15.25 $206.05
4/28/2013 $221.30 $221.30 $0.00 $221.30
5/28/2013 $221.30 $221.30 $0.89 $220.41
6/28/2013 $221.30 $221.30 $0.00 $221.30
7/28/2013 $221.30 $221.30 $0.88 $220.42
8/28/2013 $221.30 $353.80 $129.33 $224.47
9/28/2013 $221.30 $353.80 $129.82 $223.98
10/28/2013 $221.30 $353.80 $137.53 $216.27
11/28/2013 $221.30 $353.80 $130.84 $222.96
12/28/2013 $221.30 $367.71 $152.43 $215.28
Year 2013 $2,655.60 $3,332.01 $715.40 $2,616.61

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.

Student loan amortization and income-driven repayment

Under certain repayment plans, especially income-driven plans like IBR, PAYE and REPAYE for federal loans, 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 relief via a program like Public Service Loan Forgiveness.

Just remember that if you leave an income-driven plan, your interest may capitalize (get 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 can you overcome student loan amortization?

Student loan 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’re dealing with negative student loan amortization or regular, run-of-the-mill amortization, the best way to reduce the amount of interest you’re being charged is to pay extra toward your student loans — as much as you can, as often as you can (unless, of course, you’re slow-playing your loan repayment now to maximize loan forgiveness later).

Here are some things you can do 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’re 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.

2. Make it explicit that extra payments are for the principal, not the interest

Lenders and servicers will apply extra student loan 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, you could be giving up benefits like access to deferment, forbearance or income-driven repayment options should you refinance with a private lender. (Refinancing private loans is more often a no-brainer.)

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.

 

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