How to make the most of college loan repayment?

May 24, 2006 10:00 AM

How can I make the most out of repaying my student loans?

I am currently paying back my student loans from college. Each month, I usually make a payment of double or more of the monthly payment amount that the loan holder has established for me. My goal is to pay off my loans as quickly as possible, and to pay as little interest on these loans as I can. The ultimate goal here is to keep as much of my money in my pocket as humanly possible.

Whenever I overpay, I am asked to choose one of the following options:

Choice 1
Pre-Paying Principal- I do not wish to have my next payment due date advanced by the number of additional whole payments made. I understand that funds paid in addition to my present amount due will first be applied to satisfy any outstanding fees and interest and any remaining funds will be applied to my principal balance. I will continue to make payments as scheduled each month.

Choice 2
Paying in Advance - I would like my next payment due date advanced by the number of additional whole payments made. I understand that funds paid in addition to my present amount due will first be applied to satisfy any outstanding fees and interest and any remaining funds will be applied to my principal balance. While I may not have to make my next monthly payment amount, interest will still accrue on my outstanding principal balance.

Their "How are my payments applied" statement says:
Generally, payments are applied first to outstanding late fees (if applicable), then to accrued interest, and then to the principal balance. For information specific to your account, please review the information on the Payment History page.

Am I making the right choice each month? I don't see much of a difference between choices one and two, aside from when the next due date comes around. Aside from which of these choices to make, is there anything else I should do (say, changes to my account structure, monthly payment amount, etc...) that will increase the aforementioned "money-in-my-pocket" factor?

In the end, I guess another thing I am asking is - what sort of things can I do to take full advantage of the college loan repayment process in my favor?

posted by tomorama to work & money (12 comments total)

Pre-paying principal is what you want. The other option is making next month's payment now, interest included.

Say your payment is $100 and you've got $200 in hand.

If your normal payment is $80/$20 principal/interest, if you choose...

A) You've paid $180 principal and have a payment due next month.
B) You've paid $160 principal, but don't have to pay next month.

Always choosing (A) will pay things off faster.
posted by unixrat at 10:04 AM on May 24, 2006

Personally, I always chose the option that extends the due date. I never actually waited until that date, and still paid monthly, but I appreciated the flexibility it gave me. Sometimes there were tight months where all the bills came at once and it was nice to have one less bill to pay.
posted by smackfu at 10:06 AM on May 24, 2006

Um, choice 1 says:
I understand that funds paid in addition to my present amount due will first be applied to satisfy any outstanding fees and interest and any remaining funds will be applied to my principal balance.
and choice 2 says:
I understand that funds paid in addition to my present amount due will first be applied to satisfy any outstanding fees and interest and any remaining funds will be applied to my principal balance.

So it sounds like there is no financial difference if you pay the same amount at the same time regardless, and never miss a payment.
posted by trevyn at 10:10 AM on May 24, 2006

Choice 1 is the one you want as per unixrat's comment. The statement trevyn cites in option #2 is likely directed to the situation that arises when you pay, say, $220 in unixrat's hypothetical.
posted by OmieWise at 10:19 AM on May 24, 2006

As others have said, Choice 1 will pay down the loan faster (which means you pay less interest over the life of the loan.) This is what you want.

Barring cash flow issues (as smackfu suggests,) the only obvious reason to choose Choice 2 is if you'll be on a cruise or something next month and won't be able to send in a check.
posted by Opposite George at 10:31 AM on May 24, 2006

Choice 1. Your goal is to pay down the principal as fast as possible.

Interest rates are pretty low now, at least here in Canada. If you can find a loan that has a lower interest rate than your student loan, which here in Canada is fairly easy, one thing you can do is pay off your student loan in one go, and then pay back the lower interest loan. (Though interest rates are so low you might not save that much if your loans aren't huge.)
posted by chunking express at 10:33 AM on May 24, 2006

I dunno how the interest works with your student loan, but if you can get a bank account with higher interest you could save the overpayment money until you have enough to pay off the loan and make a profit. If you have any equivalent of UK ISAs (tax free personal savings accounts) you could move chunks into those. Obvously only go for investments where you can't lose any money though.
posted by lunkfish at 11:33 AM on May 24, 2006

Lunkfish beat me to it. I've been told that it is better to invest the extra money if you can find a relatively secure investment option that has a higher interest rate than your loan. The idea is that the same $100 can cancel out 5% worth of interest or earn you 10%. That is, in the long run the investment generates more money then the early payment saves.
posted by oddman at 12:06 PM on May 24, 2006

oddman and lunkfish beat me to it, but in general, interest rates on student loans are about the lowest you will ever get on any loan, especially if you have federal loans and consolidated them when the interest rates were super-low. A modest rate of return on a safe investment would most likely exceed the interest accrued on your student loan. So even if you could pay off your debt today, you'd be smarter to invest the money somewhere and pay your loans off slowly.
posted by mds35 at 1:21 PM on May 24, 2006

I see that you're located in the U.S. Based on that, you should strongly consider making only the minimum payments on your loans, and putting the rest in a bank account. A long-term money market account (which is, from your perspective, just an FDIC insured savings account) will currently pay you almost 5% APY. Add on to this the fact that inflation is currently averaging about 3.5%, and you've got a strong case for leaving that debt out there for the 25 year maximum period, and paying it in much smaller real dollars, and possibly even pocketing a bit of profit off of a riskless investment.

For rates and a comparison of the bank accounts that I mentioned, take a look at this and this.
posted by gd779 at 1:30 PM on May 24, 2006

You need to look at your agreement (NOT your payment coupon) and make sure you actually can pre-pay and have it impact the principle. Note the language:

will first be applied to satisfy any outstanding fees and interest and any remaining funds will be applied to my principal balance

So you may not be accomplishing anything. The two choices would seem to indicate that you are, but the language seems to allow wiggle. Note this article which talks about no-prepayment clauses.

Please note, however, that your loan may have a prepayment clause that prevents you from being able to reduce the interest paid.

If that's your situation then you most certainly want to find another destination for this money which will make you some interest.
posted by phearlez at 2:23 PM on May 24, 2006

With both of my lenders, if you agree to pay via their electronic debit, they will have a quarter per cent off the interest rate. Maybe your lender(s) has a similar arrangement?
posted by FergieBelle at 5:18 AM on May 25, 2006