Lately, I’ve felt so free discussing my debt-free goals with close friends in China. When I shared how I finally paid off my undergraduate student loans 9 years and 1 month after walking across the stage, my friend, Ti, told me about a former co-worker who was taking longer than that.
This single father is approaching 40. One day, he looked at his statement and grew frustrated. The balances weren’t going down. He had been paying extra for a few years.
He called the company to complain. Little did he know that his extra payments weren’t being applied to his principal.
“Oh, no!” I groaned. “You gotta tell your money where to go.”
I’m sure many of us have played the leading role in this cautionary tale. But a few years ago, I wised up (pun intended). I learned how to make sure extra payments applied to my principal—not just my interest.
WHAT PAYMENT PLAN AM I ON?
Of all the repayment plans offered by FedLoan Servicing, I am on the Extended Fixed Repayment Plan with a maximum repayment term of 25 years. I have fixed monthly payments that are much lower than what I originally had with the 10-Year Standard Plan. The payments are lower because the repayment term is 15 years longer.
I chose the Extended Fixed Repayment Plan because I knew I wouldn’t be seeing public forgiveness. Also, the monthly payment stays the same (“fixed”) throughout the entire 25-year repayment term. That means that I can always budget around that number, which came in handy when I moved to China and had to create a new budget.
Plus, with the student loans being fixed, I could put extra money toward my credit card debts, which had a much higher interest rate than my student loans. I knew I always had the option of paying off the loans faster after I paid off the high-priority debts in the debt snowball. It was a win-win-win for me.
When you’re considering making extra payments, you must consider how it’s going to affect your repayment plan. According to FedLoan Servicing:
Paying on an Income-Driven Repayment (IDR) Plan
You cannot pay ahead past your IDR anniversary or recertification date. Any extra funds remaining at the time of your IDR anniversary or recertification deadline will be immediately applied to your loans (not to a future bill), and your paid ahead status will end. However, you still have the option of paying extra, and you can enter paid ahead status again, through your next IDR anniversary or recertification.
Considering Public Service Loan Forgiveness (PSLF)
Paying ahead while seeking PSLF can adversely affect your qualifying payment count. If you pay extra and enter a paid ahead status while seeking PSLF, any future bills that you satisfy may not immediately count as qualifying payments. If you want to pay more than your required monthly payment, please contact us and request to have paid ahead status permanently removed.
HOW EXTRA PAYMENTS WORK
Here’s the skinny: The principal balance is the amount you agreed to borrow. Interest is the cost of borrowing the principal. When you don’t reduce the principal quickly, the interest keeps growing.
Credit lenders want to keep you around for a long time. The longer you pay interest, the longer you’ll make them rich. When you send extra payments, most student loan servicers apply it to the interest first and then future payments. Well, UNLESS you tell them otherwise.
For example, here’s how FedLoan Servicing applies payments on up-to-date accounts:
When your loan is not past due, we apply your full payments like this:
- Accrued interest—The amount of interest that accrued every day between the date of the last payment and the new payment is satisfied first.
- Current principal balance—The remainder then applies toward your current principal balance.
- Extra amount—If you pay more than the total amount due, we will apply the extra amount toward the principal amount due of a future bill (if you have one), unless you qualify for a $0.00 payment with Income-Driven Repayment. The extra amount is spread across your loans based on the amount due for each loan. This may place your loans in a paid ahead status.
The extra amount goes to a “future bill” and “is spread across your loans based on the amount due for each loan.”
NO, THANK YOU!
We want our hard-earned money to go toward our principal RIGHT NOW. And we want to target payments.
Many of us have several loans in a loan group. We already know that we want to send extra money to one debt at a time using a repayment strategy like the debt snowball or debt avalanche. When we pay that off, then we roll over that payment into the next debt to increase our debt eliminator (all of the extra money we designate for debt payoff).
Spreading money across multiple loans means two things:
- You’ll pay down debt more slowly.
- You’ll pay more money in interest over the lifespan of your loan.
Consider this example from a Consumer Financial Protection Bureau report. A woman has three loans within one billing group at various interest rates. They have the same starting balance of $10,000. She pays $100 extra per month until her loans are paid in full.
If her servicer divides the extra $100 evenly between her three loans, she’ll save $4,514.98 over the lifespan of this loan. If her servicer applies the extra $100 to the loan with the highest interest rate, she would save $5,403.62. That’s nearly $900 more than what she would save with an even split.
PROBLEM: Servicers may not apply your extra payments toward the principal on your loan with the lowest balance (debt snowball) or the highest interest rate (debt avalanche).
SOLUTION: Take control, target payments and tell servicers how to apply extra payments.
3 WAYS TO TELL YOUR SERVICER HOW TO APPLY EXTRA PAYMENTS
1. Send written instructions to your servicer.
That’s right! Send instructions to your servicer about how it should apply your extra payments to individual loans. Identify your loans by disbursement date and loan type. Download, complete and mail a sample letter from the Consumer Financial Protection Bureau and the exact letter I sent to FedLoan Servicing, the servicer for my graduate student loans, in September 2017. My two balances were nearly identical, so I decided to target the loan with the highest interest rate.
Dear FedLoan Servicing:
I am writing to provide you with instructions on how to apply payments when I send an amount greater than the minimum amount due via Direct Debit. Please apply payments as follows:
After applying the minimum amount due for each loan, any additional amount should be applied to the loan that is accruing the highest interest rate. In this case, that loan is the Direct Student PLUS Loan with a 7.65% interest rate.
It is possible that I may find an option to refinance my loans to a lower rate with another lender. If this lender or any third party makes payments to my account on my behalf, you should use the instructions outlined above.
Please retain these instructions and apply these instructions to all future overpayments. By mail or email, please confirm that these payments will be processed as specified or please provide an explanation as to why you are unable to follow these instructions.
Thank you for your cooperation.
FedLoan Servicing replied a month later and said, “We received your instructions and will apply your payments accordingly.”
The servicer reminded me that “we can only target payments in excess of the minimum amount due for your loans. We must apply the payment first to any outstanding interest and then the rest of the principal balance.”
For example, your balance is $1,000 and you have outstanding interest of $100 on the day you make a $500 payment. Therefore, $100 would be applied to the outstanding interest and the remaining $400 would be applied to the principal.
$500 payment = $100 to outstanding interest + $400 to principal balance
2. Make target payments online.
Here’s how targeting payments works for FedLoan Servicing.
- Step 1: Sign into your account.
- Step 2: Select the “Specify Loan Payment Amount” tab.
- Step 3: Input the amount you wish to pay toward each individual loan in the “Payment Amount” field.
- Step 4: Hit the “Make a Payment” button.
There are two options for making a target payment after you sign into your account.
- Option A: Click “Make Payment” under “Payments & Billing” on your dashboard.
- Option B: Click “Payments & Billing” and “Make a One-Time Payment” on the left sidebar.
Click “Target Specific Loans” and enter the following information:
- The amount you wish to pay toward an individual loan under “Payment Amount” (REMEMBER: The extra payment will be applied to outstanding interest before your principal, so send an amount that covers the interest. Call your servicer if you’re not sure about the amount of outstanding interest.)
- The “Payment Date“
- The “Saved Bank Account” from which the payment will be made
Then click “Make A Payment.”
NOTE: In this example, I have already paid the minimum amounts for August 2018 via Direct Debit. This is an extra payment for August.
Verify that your information is correct on the next page. Then agree to the terms and conditions and press “Verify & Submit Payment.”
Then a confirmation page will appear.
If you have not already received confirmation that the servicer will apply the extra money toward your principal as you instructed, then call your servicer after the payment posts to make sure it was applied to your principal. It wouldn’t hurt to call them anyway to make sure the money was applied properly. You don’t want to be like that single dad. Better safe than sorry.
If you don’t deal with FedLoan Servicing, then please contact your servicer to understand this process for your particular situation. Amanda at DebtFreeInSunnyCA.com has written instructions for Navient, Nelnet and Great Lakes.
3. Make target payments by phone.
At one point, I had six active loans in my undergraduate loan group with the College Foundation of North Carolina. I paid $100 via direct debit every month to take advantage of the slight interest rate reduction. (FedLoan Servicing offers this service, too.)
I called CFNC and asked them to start applying extra payments to the loan with the smallest balance so I could pay it off quicker. In June 2017, I noticed that the money wasn’t allocated correctly. I phoned them again and reminded them of the instructions. They fixed the error within 48 hours.
Don’t be afraid to advocate for yourself. If you don’t, then who will?
Whenever I had enough money to make my minimum payment and an extra payment to knock off a loan in full, I’d also call CFNC directly. The staff and I got to know each other really well.
- Step 1: I waited until my direct debit cleared for the minimum payments to see the new balances on all of the loans online.
- Step 2: I called CFNC to see how much I’d need to sent to pay off a particular loan in full.
- Step 3: I made an extra, one-time payment online for that amount.
- Step 4: I told the staff on the phone to make a note on my account that this was a principal payment for Subsidized Loan #4, for example.
- Step 5: I waited 48 hours for the payment to post and viewed the new balances online to make sure the money was applied correctly and I could see “Paid In Full.”
The moral of the story is don’t let other people decide what to do with your money.
- Make targeted payments toward the principal of one loan at a time.
- Contact your servicer immediately.
- Give clear instructions to your servicer about how it should apply extra payments to individual loans’ principal balances.
- Follow up with your servicer to confirm payments are being applied correctly.
- Speed up your debt repayment process.
This strategy could work for paying off mortgages and other lines of credit. You work hard for your money. Make sure it’s working hard for you.