Student loan borrowers sometimes wonder why they aren’t making as much progress paying down their student loan debt as they expected.
For example, a typical scenario might involve a college graduate who borrowed $40,000 to pay for college, has repaid $35,266 in the five years since graduation and yet still owes $29,075. It certainly seems like this borrower is not making much progress in paying off the loans, especially on a 10-year repayment term. But, this scenario is consistent with a borrower whose loan balance was $50,000 when the loan entered repayment. The $10,000 higher loan balance at repayment is due to interest and fees that accumulated during the in-school and grace periods.
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Factors Affecting Repayment Progress
There are several factors that can affect a borrower’s real or apparent progress in repaying student loan debt:
Comparisons with the amount originally borrowed, not loan balance at repayment. The monthly loan payments are based on the loan balance when the loan entered repayment, not the amount originally borrowed. The loan balance at repayment is often much higher than the amount originally borrowed. Not only are loan fees added to the loan balance (about 1% to 4% of the loan amount, depending on the type of loan), but also the interest that accrues during the in-school and grace periods. This accrued but unpaid interest is capitalized by adding it to the loan balance. The combination of capitalized interest and loan fees may increase the loan balance by as much as 25% when compared with the amount originally borrowed.
Deferments and forbearances after the loan enters repayment. Interest continues to be charged during a forbearance. Even during a deferment, interest continues to be charged on unsubsidized student loans. If this interest is unpaid as it accrues, it will be capitalized by adding it to the loan balance.
Negative amortization. Negativeamortization occurs when the monthly payment is less than the new interest that accrued since the last loan payment. The unpaid interest is added to the loan balance. Some repayment plans, such as the income-dependent repayment plans, are negatively amortized.
Interest rate. A higher interest rate causes more interest to accrue between loan payments, so more of each payment will be applied to paying down interest before the remainder is applied to reducing the principal balance.
Late, missing or partial payments. Interest continues to accrue on a loan, regardless of when a payment occurs. There is no freezing of the loan balance. Payments are applied to the loan when received. The payment is first applied to the interest that has accrued and second to the principal balance. So, if a payment is received late, more interest will have accrued, leaving less of the payment available to pay down the principal balance of the loan. In addition, late fees may be charged when a payment is received late, increasing the amount owed.
Borrower makes lump sum payments instead of regular payments. If a borrower makes a lump sum payment once a year, instead of monthly loan payments, more interest will accrue in between payments. This causes more of the payment to be applied to paying off the interest and less to paying down the principal balance.
Collection charges. If a borrower defaults on a federal student loan, collection charges of up to 20% may be deducted from each payment before the remainder is applied first to interest and second to principal. This leaves less money to pay down the principal balance, slowing the progress in paying off the debt.
Longer repayment term. A longer repayment term reduces the monthly payment. Since payments are applied first to interest and second to principal, a lower monthly loan payment leaves less money after paying the interest to pay down the principal balance. Also, since the loan balance is higher for a longer period of time, more interest will accumulate between payments. This means it will take longer to pay down the debt. To speed up progress in paying down the debt, choose a shorter repayment term with a higher monthly loan payment, so more of the loan payment will be applied to paying down the principal loan balance.
Student loans are similar to home mortgages in many ways. Most of early loan payments are applied to the new interest that accumulates, not the principal balance. So, progress in paying down the loan balance is slower during the first few years of the loan repayment term. It is only toward the end of the repayment term that progress in paying down the principal balance accelerates.
Measuring Progress in Paying Down Debt
This table estimates the number of years into repayment before the specified fraction of the loan balance at repayment has been repaid. The figures are approximate, based on a typical range of interest rates. The actual number of years may vary by as much as two years in either direction.
Years to Pay Down 25% (1/4) of Loan Balance
Years to Pay Down 33% (1/3) of Loan Balance
Years to Pay Down 50% (1/2) of Loan Balance
Generally, it takes about two-thirds of the repayment term before the borrower has paid off half of the loan balance at repayment.