If you’ve completed a degree or spent time at college, odds are you never want to hear the phrase “Back to school” again. Worse yet, this time of year often kicks up some guilt and stress for 69% of graduates who are saddled with (on average) about $30,000 in student loan debt.
If you’re one of the lucky ones who are still paying for their college experiences, the monthly payments and interest may seem like a necessary evil. But it helps to take a good look at what type of student loan you have, so you can understand what to do to get that debt paid down faster.
Types of Student Loans
While they’re often advertised as equal, there are actually different types of school loans. When you start paying off your loan, it’s helpful to know how each type operates, so you can plan accordingly.
Subsidized federal loans
These loans are some of the most common, and (as of July 2019) possess an interest rate of 4.53%. However, your interest rate will be different, based on when you entered into your loan. You must demonstrate financial need to qualify, however, which is why many people have to accept unsubsidized federal loans. The federal government pays your interest while you are in school, so you only begin to accrue interest upon graduation.
Unsubsidized federal loans
These have the same interest rate as subsidized federal loans, but can be taken out by someone regardless of financial need. They also begin accruing interest from the day the loan is disbursed.
Direct and parent PLUS loans
These loans are not based on financial need, but you or your parents had to qualify with a clean credit history. A direct PLUS loan is direct to the student, while a parent PLUS loan is under the parent’s name. Unlike federal loans, there is no limit for how much you can take out in PLUS loans. They also start accruing interest from the day of disbursement.
These loans are essentially just “bundled” federal loans, making it easier to have everything under one payment. A fixed, average interest rate is calculated and the consolidated loan will accrue interest at that decided rate. Depending on the federal loans consolidated, you may also have accrued interest throughout school.
How the Type of Loan Affects Your Repayment
As you can see from the above descriptions, not all student loans are made equal. Many of them are unsubsidized — which means they accrue interest while you’re in school and continue to do so after you graduate. Why does that matter? Because the longer you’re paying interest, the more you’ll have to pay over the life of the loan.
Let’s do a quick calculation. Let’s say you took out the “average” amount of $30,000 in school loans with a 4.53% interest rate your freshman year. If that’s an unsubsidized loan, you’ve already accrued an additional $1,359 in the first year in interest alone. That means your second year of accruing debt (your sophomore year), you’ll be paying 4.53% interest on $31,359. By the time you graduate with a 4-year degree, you’ll be paying compound interest on a total of $35,816 — over $5,000 more than you took out. Interest will continue to accrue at 4.53% on the $35,816 total amount.
Of course, if you have a subsidized loan, you’ll leave school with the original loan amount and the 4.53% interest kicks in the day you leave school. This is why it’s so important to know what type of loan you have, so you can plan accordingly for your paydown process. It’s also important to know the difference between “total amounts” and “principal amounts” so that you are actually making a dent in your balance with each payment.
The Principal vs. Interest Race
On your student loan statement, you should have a breakdown of your specific payment. There’s usually your loan account details, such as total balance, payment amount, payment due date, etc., but there’s also a longer section showing billing details and a snapshot of your loan. Find line items like “Original Principal Amount” or “Outstanding Principal Balance” to see what your actual loan amount has been paid down to. If you’ve been paying on your $30,000 at $200 a month for 1 year, let’s say, your principal (if no interest was accrued) would be about $27,600. Of course, you’re collecting interest, so that number likely looks closer to $28,950.
This means that your interest is essentially blocking you from paying down that principal amount — the amount you get charged interest on. So, the idea is to pay down the principal faster so your interest accrued decreases accordingly. But how do you do that?
How to Pay Down Your Principal to Save Money
There are a few ways to pay down the principal on your student loans. Depending on the type of loan you possess, you may be able to simply make additional payments to the total balance online or via check. In other instances, you may need to call your lender and ask to pay down the principal balance with a lump sum separate from your minimum payments. In general, though, the best way to pay down that principal and beat the interest is to simply pay more than your minimum balance. The longer you have a loan, the more the lender makes on interest. So it’s in their best interests to keep your minimum payment low. But it’s not in YOUR best interest.
So take a look at your budget and ask yourself: Is there anywhere I can cut back each month so I can channel more money towards my student loans? If the answer is no, that’s OK! Check back in a couple of months. If the answer is yes, all you need to do is set up a higher minimum payment on your autopay, or write a slightly larger check each month. And, no matter what you do, don’t skip a payment! Even if you pay ahead or pay more, you will accrue fees and more interest if you skip a regularly scheduled payment.
Committing to Your Goals
Hopefully, this helps you understand a little bit about your loans and why they seem to never go down. When you pay more than the minimum balance, you’ll pay down your debt faster and have more money to set aside in the future, for things like travel, houses, kids, and retirement. But if you’re struggling to find create a budget that helps you pay down your student loans, or you need more guidance with debt repayment and personal finances in general, let us know.
We want to help you feel less stressed and overwhelmed by your finances, especially when it comes to student loan debt. Hannah Moore (founder of Everyday Money) is a Certified Financial Planner™ who holds Money Clarity sessions — 60 minute Skype sessions — with individuals and couples who really want to get to a better place with their money. Don’t be shy! Reach out.