Is It Really Worth It to Make Extra Student Loan Payments?

By
Teresa Ruiz Decker
,
October 31, 2018

It’s finally happened—you’ve reached a point of financial stability and the money side of life is starting to feel a little easier.


Maybe you’re making enough to stop living paycheck to paycheck, got your financial house in order with a budget, or an unexpected chunk of change came your way. Whatever it is, you’re now in a better place with your money and you can start focusing on financial goals instead of being in survival mode. Nice work!


Thanks to your new financial bump, you’re in a much better position to pay off your loans faster by putting down extra payments. Of all the tactics I tried to pay off my $60K in student loans, extra payments were by far one of the two most effective strategies (the other was refinancing my student loans).


Sure, it was tough sometimes, but I found putting small amounts of extra cash toward paying down my student loan was a solid strategy that made a huge difference. Even something as simple as an extra $100 a month can save you thousands on interest over the long haul.


Here’s a closer look at how extra payments work and some tips on how to use extra payments to get you to the student loan payoff finish line faster.


Start by specifying where extra payments are applied (before making an extra payment)


If you’re new to making extra payments like I was, you may think the process is pretty straightforward. Make an extra payment and your balance will go down.


Unfortunately, it’s not that simple. It never occurred to me that my extra payment wouldn’t directly go toward my principal.


I learned the hard way that payments are actually applied to your loan in the following order:


  • First, outstanding fees
  • Next, interest
  • And finally, the principal.  


That’s right, your principal sees the money last. If you have several loans, the extra payment could be spread across all of those loans in the same fashion, decreasing the impact on your principal significantly.


In my case, I started off with six loans with very different interest rates. One loan’s interest rate was as low as 3 percent, while another’s was nearly 8 percent.


I had planned for my extra payments to be applied toward the higher interest loan (also known as the avalanche method) but after a conversation with the loan company, I was told the payment would be applied toward all of my loans. First, the payment would cover the daily interest accrued, then the remainder of the payment would be applied evenly to all loans. That was a huge letdown for me at the time.


It wasn’t until later that I learned you can actually direct lenders on how to apply your extra payments after all interest and fees have been covered. The Consumer Financial Protection Bureau has a fantastic letter you can use to get you started and save time.


The letter clearly and concisely requests lenders apply your payment toward the minimum amount due for each loan and put any additional amounts toward the loan accruing the highest interest rate. If there are multiple loans with the same high-interest rate, additional funds should be applied toward the loan with the lowest outstanding principal balance.


You can view and download the complete sample letter here.


As you think about how your own extra payments will be applied, revisit the terms of your loans to make sure you understand any fees associated with extra payments or prepayment of your loan.


For some lenders like CommonBond, making an extra payment is no sweat because there aren’t any prepayment penalties. Other companies may have different terms, so double check the terms before sending your letter and extra payment.


Think about the timing of extra payments


Timing your extra payment is important, since interest accrues daily on most student loans after your grace period has ended.


As you explore different ways of making extra payments you’ll notice making smaller extra payments more often may provide the chance to save more on interest over the long-term, while larger one-time extra payments may provide a greater sense of progress.


If you were to make biweekly payments (once every two weeks) of half your monthly payment on a $60,000 loan with an interest rate of 5.3 percent, you could be debt free 12 months sooner and save $1,935 in interest. This is because a biweekly schedule allows you to essentially make two additional payments per year.


I tried many approaches on my all-out on my quest to conquer student loans, including bi-weekly payments. After experimenting with different extra payments, I found it was more meaningful for me to make large payments every so often so I could see my balance go down and experience some small wins.


You may also want to try a few approaches to see which feels right for you.


Ways to make extra payments

Now onto the good stuff. You’re ready to make an extra payment, but which way is best for you? Should you do a little each month? Or save up and put down a sizable extra payment?


There are a few ways to look at this depending on how your extra money comes in and your personal preferences.


Paying a little more each month: This is a great strategy for someone who is experiencing a bump in their salary or regular income. By using your salary increase to consistently pay a little more monthly, you can save on interest in some surprising ways.


It might not seem like much in the beginning, but over time, consistently making extra payments can have a big impact. Take the example of a 10-year, $60,000 loan with a 5.3 percent interest rate. If you decide to make an extra $100 payment a month you can actually save $3,124 in interest over the life of the loan and reach your pay off date one year and eight months sooner.


Lump sums: If you get a sizable amount of money, consider making an additional lump sum payment toward your balance. Tax refunds, unexpected birthday gifts, and work bonuses are all great candidates to help you knock out student loan debt faster.


In my case, picking up freelance projects and renting a room out on Airbnb were two good ways to make extra sums of cash I threw at my student loans. There were some months I’d pay $200 extra dollars and others where I would make a $1500 extra payment. Whenever extra money came my way, I put it toward my loan.


There were times I squirreled away some of the cash for my savings cushion or other necessities but overall, using extra money for my loans felt very rewarding because I saw the balance go down so much after each lump sum payment.


Returning to our example of the $60,000, 10-year student loan at a 5.3 percent interest rate, by using a tax return of $2,000 toward your student loan, you could save $1,359 on interest and pay off the loan five months earlier—and that’s just with one extra payment!


Refinancing + extra payments: This last approach is when I started to see real results. I’d been making good progress on my student loans but it was a real slog because the interest rate was so high.


At about the $25,000 mark, I decided it was time to look for a lower rate than the 5.75 percent I had been paying. That’s when I found CommonBond. The combination of a much lower interest rate with an aggressive lump sum payment approach paved the way for me to pay off my loan early.


Let’s say the $60,000, 5.3 percent, 10-year student loan was refinanced to a 3.2 percent interest rate. The refinance alone would save $7,237 over the life of the loan. If you add in one extra lump sum payment of $2,000 you could shave off another $642 in interest and pay off the loan four months sooner.


That’s a total of $7,879 saved just from refinancing and one lump sum payment.


Whether you decide to make smaller extra payments each month or place larger sums of money toward your loan whenever possible, you’ll still come out ahead. Extra payments help save on interest and pay off student loans sooner.


Now that my student loans are paid off, it feels incredible to be financially free and I can honestly say it was totally worth it to make those extra payments. I’m so glad I made the short-term sacrifice to experience financial freedom sooner. I’m sure you will be, too.

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