What does the American dream look like today? Well, there’s a cozy house surrounded by a white picket fence, two kids, a dog playing in the yard and, of course, thousands of dollars in student loan debt.
Americans are collectively paying down a record $1.5 trillion in outstanding student loan debts, with the average college graduate now taking on $29,000. Managing that debt is already a challenge that requires a disciplined strategy, but confusing repayment policies from the companies servicing those loans can leave well-intentioned borrowers feeling burned.
Here’s an all-too-common occurrence: A borrower makes extra payments on their student loans to get ahead, only to find their balance hasn’t budged. In some cases, as alleged in a suit (still in litigation) filed in 2017 by the Consumer Financial Protection Bureau against loan servicer Navient, borrowers may be racking up late fees, interest charges and hits to their credit score — all for making extra payments.
While it's not a bad idea to pay student debt faster if your budget allows, you want to make sure you’re doing it the right way — and not being penalized for it. Here’s how to avoid a major student loan mistake.
WHEN PAYING EXTRA GOES WRONG
The problem isn’t making extra payments; that’s actually a pretty good idea. The trouble is how those extra payments are processed.
When you pay your student loans, you’re taking care of a few line items before you make a dent in the balance. For federal student loans, regulations require that payments are first used to cover outstanding fees, then interest and finally your principal (that’s the number you want to see shrinking every month). But if you pay extra on your bill, some loan servicers will apply that payment to next month’s bill rather than to additional principal on your current bill.
That means instead of taking a larger bite out of principal, your extra payment simply pays next month’s fees or interest charges. Some servicers apply every extra payment to future monthly bills, essentially moving the due date for your next payment ahead. In financial speak, they consider your account “paid ahead.”
Ready to take the next step? A financial advisor can show you how all the pieces of your financial plan fit together.
Here’s a quick example. If your bill is $250 (interest, fees and principal) in January, but you decide to pay $1,000 that month, the loan servicer may apply that extra $750 to cover February, March and April bills (not $750 in additional principal to January’s bill). They’ll consider you “paid ahead” and your next payment won’t be due until May. If you’re on an autopayment plan, the servicer may not withdraw another payment until May.
Ultimately, that defeats the purpose of paying early, which is to carve out larger chunks of your principal balance. When extra payments get stretched out to future bills, you’re not actually getting ahead any faster, despite paying more. Frustrated? You’re not the only one: student loan payment processing issues are a leading complaint lodged with the CFPB.
HOW TO PAY EXTRA ON YOUR STUDENT LOANS THE RIGHT WAY
Here’s how to solve this one. Dig into how your loan servicer applies extra payments. For example, check out the guidelines from Navient. Then, log into your student loan accounts and review the payment options you have selected. You should have several choices that can help your loans shrink faster.
First, adjust your payment options and make sure extra payments are used for additional principal, and not next month’s bill or something similar. You can also choose which loans should get a larger chunk of that extra payment. Funneling extra payments to loans with higher interest rates can help you get ahead a little faster.
Of course, if you can’t do all of this online, you can contact your loan servicer by phone or email and tell them how to handle your extra payments.
The CFPB offers a handy sample letter that you can send to your loan provider or servicer to tell them where to allocate your payments. You can also specify how you’d like extra payments allocated or which loan you want to pay down first.
If you feel a financial company has wronged or misled you, you can submit a complaint to the CFPB regarding your issue. Remember; when it comes to your student loans you have a choice and a voice.