Is it Better to Pay Off Interest or Principal on Student Loans?February 25, 2021
Most student loans, like other loans, come with interest charges that accrue over time. As a result, you can usually expect to repay more than you originally borrowed.
Depending on the type of student loan you get, you might be able to defer your interest until a later date. However, in the end, you eventually need to make both principal and interest payments. Once you learn about principal vs. interest, you can learn how to pay principal on student loans in order to reduce what you end up spending over time.
Student Loan Principal vs. Interest Payments
Your student loan principal is the original amount that you borrowed. Interest is the fee charged for borrowing the money and is usually expressed as a percentage of your loan amount. When you make a principal payment vs. regular payment, all of what you send to your servicer goes toward reducing your loan balance.
However, in general, student loan payments aren’t applied toward the principal first. Here’s how student loan interest and principal payments are handled most of the time:
- Your lender applies your payment to loan fees
- Additional funds cover your monthly interest
- Excess funds may be used toward your loan’s principal
For the most part, your payment is set up to include loan fees. After that, if you pay less than the standard repayment amount, your servicer will put the money toward your interest, but not your principal. With some income-driven repayment plans, you could be paying toward interest and never get into making principal payments.
If you pay extra each month, you need to let your servicer know that you want it applied to your principal. Otherwise, they may just apply it to your next payment, putting it toward fees and interest before reducing the principal.
Types of Student Loans and How They Accrue Interest
Understanding the types of student loans and how they accrue interest can help you save money in the long run. This is especially true once you learn how to pay principal on student loans.
- Federal Direct subsidized loans: These federal loans have a fixed interest rate and the government pays the interest accrued while you’re in school.
- Federal Direct unsubsidized loans: Like subsidized loans, the interest rate is fixed. However, the government does not pay interest and it begins accruing while you’re in school. If you don’t make interest payments during college, the accrued interest is added to your loan balance after you graduate.
- Federal Direct PLUS loans: There’s a fixed rate with PLUS loans, and interest begins accruing immediately. Any amount of interest not paid during school will be added to the loan.
- Private student loans: Terms vary with private student loans, so you could end up with a variable interest rate rather than a fixed rate. Interest begins accruing immediately. On top of that, some lenders require you to begin making payments while you’re in school.
Federal Direct subsidized and unsubsidized loans come with a six-month grace period. Normally, you don’t have to make payments until that ends. However, your unsubsidized student loan interest is still accruing. PLUS loans and private loans don’t always come with grace periods, so you might need to ask for a deferment.
Why It’s Important to Make Extra Payments on Student Loans
When you make extra payments on student loans, using a principal payment vs. regular payment, you can pay down the amount you originally borrowed and reduce the total interest you pay.
Because interest is based on the amount of your remaining principal, when you learn how to pay principal on student loans, you’ll also decrease the amount of interest accruing each month. Making extra payments reduces your total cost and helps you pay off student loans faster.
How to Pay Off the Principal Balance on Student Loans
As you decide whether to make principal vs. interest payments, be sure to choose the approach that best fits your goals. Here are two ways to reduce your principal balance faster:
- Make interest payments while in college: Even though you normally don’t have to, consider making interest payments on applicable loans while in college. That way, on private, unsubsidized and PLUS loans your accrued interest isn’t added to your principal when you graduate.
- Pay more than is required: When possible, make a larger than required student loan payment. Specify that you want the extra amount to go toward your student loan principal. When interest is figured the following month, the smaller principal will mean a lower interest payment.
Choose Which Student Loans You Want to Pay Off First
The best way to repay student loans, if you want to save money on interest and reduce your principal faster, is to tackle the loans with the higher interest rate first. Loans with higher rates accrue interest faster, so getting rid of those first can save you money in the long run. Depending on your servicer, you may be able to choose which loan should get the extra payment first.
Speak With Your Student Loan Servicer
When making a principal payment vs. regular payment, you need to let your servicer know how to apply the extra money. Otherwise, the servicer may apply it toward fees or interest instead of reducing the principal. Make sure you’re clear that you want any extra amount to go toward principal reduction.
Verify That Extra Payments Are Being Applied Properly
Review your monthly statement and make sure your extra payments are going toward principal, as you requested. If there’s a problem, contact your servicer and reiterate that you want additional payments to go toward the principal.
How to Pay Off Interest on Student Loans
There are times when making interest-only payments can make sense.
- If you’re in school and have private, federal unsubsidized or PLUS loans, making interest payments can help minimize the amount of interest that you’ll have to pay after you graduate.
- Making interest payments during the post-graduation grace period can help keep your accruing interest balances low.
- If you need forbearance or deferment due to hardship, you can continue to make interest payments to keep interest charges from accruing.
Realize that, even if you’re not required to make student loan payments, interest could still be accruing depending on your loan type and terms. Speak with your servicer about making interest-only payments so that you can keep accruing interest balances low.
Consider Student Loan Refinancing For Lower Interest Rates
One way to reduce your interest rate so that more of your payment goes toward principal is to refinance your student loans. Some of the benefits of student loan refinancing may include lowering your student loan interest rate and changing your student loan repayment term. You can even refinance student loans while in school.
Be aware, though, that refinancing your federal student loans means you could lose benefits like income-driven repayment and the opportunity to participate in Public Service Loan Forgiveness.
Refinance Your Student Loans With ELFI
If you’re interested in a better student loan interest rate, consider applying to refinance with ELFI. You can even estimate how much you could save by using the Student Loan Refinancing Calculator.*
Student loan refinancing can be one way to pay down both principal and interest faster and save money on your student loans. Carefully consider your situation to make the best choice for you.