How to make principal-only payments on student loans

fizkes // Shutterstock Making principal-only payments on student loans (either monthly or just occasionally) can help speed up the payback time and lower your overall borrowing costs. But just making extra payments on your loan won’t necessarily lower your loan’s principal balance. You typically need to take a few extra steps to ensure that your extra payments actually go toward the principal–and not interest on the loan. SoFi shares exactly what a principal-only student loan payment is and how to be sure you’re doing it right. Key points Making principal-only payments on student loans can accelerate the payback period and reduce overall borrowing costs. Extra payments need specific instructions to ensure they go toward the principal, not future interest. Lenders might automatically apply extra payments to future bills unless directed otherwise. Online payment platforms often allow borrowers to specify that extra amounts are principal-only payments. Regularly monitoring account statements is crucial to confirm that payments are applied correctly. What Is a Principal-Only Student Loan Payment? To understand what principal-only payments are, it helps to understand how student loan repayment works. When you take out a student loan, you need to repay the principal balance. (the amount you borrowed), interest (the cost of borrowing the principal) and, in some cases, fees (which are often paid up front). When it’s time to start repaying your student loan, you are usually required to make at least a minimum payment each month. That payment will go towards both your principal balance and interest. In the beginning, most of your payment will go toward interest and very little towards principal. Over time, however, the balance shifts more of your monthly payment will go toward the principal and less will go toward interest. Fortunately, student loans have no prepayment penalties. This means that If you make an extra, principal-only payment, it will lower the principal balance of your loan, and the lender will not be able to charge you a fee for paying some of your loan off early. Unfortunately, when a lender receives a payment beyond the minimum due each month, they may simply apply it to next month’s bill rather than use that money to lower your principal. This means there are certain steps you need to take to make sure the money will only go towards principal (more on that below). Why Making Principal-Only Payments Can Make a Difference Since interest on a student loan is calculated daily on the principal balance at that time, the less principal you have left to pay, the lower your interest costs. As a result, paying extra on your student loan — and having that money go directly to the principal–can save you a significant amount of money. It also helps you pay off your student loans faster. Of course, not everyone is in a position to pay more than the required amount in any given month, and that’s fine, too. You might simply choose to use an occasional windfall–such as a bonus at work or a cash gift–to make a principal-only payment on your student loans. How to Make Principal-Only Payments on Student Loans Just making an extra payment on your student loan doesn’t necessarily mean you are making a principal-only payment. Generally, student loan servicers apply your payments first to cover any late fees you’ve incurred and then to accrued interest before they apply anything to your principal. Here are some tips that can help ensure any extra payments you make go toward your principal. Tell Your Lender Where to Direct Extra Payments If you pay online through the servicer’s website, you might have the option to choose how the money gets applied. There may be an option that says “other amount” where you can enter an extra amount you want to pay towards your loan that month, as well as where that money should be applied, such as to the interest only, the interest and principal, or just the principal. In some cases, you might see an option for “Do not advance the due date.” Clicking this will ensure that your lender treats your funds as an extra payment rather than applying them toward next month’s bill. If you want to make a larger payment every month and have the extra applied to the principal, you may also have the option of setting up standing instructions online, telling your servicer to send any extra money towards the principal. If you pay by check or don’t see these options online, you’ll need to contact your loan servicer and ask how to make occasional or regular principal-only payments. You may need to send a standing order in writing. Apply Extra Payments Strategically If you have more than one student loan, you can typically request that your student loan servicer apply your extra payments to a specific loan (such as the loan with the highest interest rate) in order to ensure you can save money and meet your debt repayment goals. There are two common approaches to paying down debt on multiple loans: The snowball method. This involves paying off the smallest loan first, then moving on to the next-biggest loan. This approach can give you a sense of progress and motivate you to keep going. The avalanche method. This tackles the loan with the highest interest rate first. Putting extra payments on the most expensive loan will save you the most money. However, it won’t allow you to cross a loan off your list as quickly. Keep a Close Eye on Your Statements To make sure your principal-only payment was just that–it went to principal only–it’s a good idea to check your online account or loan statements each month to make sure any extra payments you made were correctly applied. You’ll also want to make sure the money was applied to the loan you specified. If your lender didn’t apply your extra payment to the principal balance, you’ll want to reach out to ensure that future payments are accurately applied. Quick tip: Federal student loans carry an origination or processing fee (1.057% for Direct Subsidized and Unsubsidized loans first disbursed from Oct. 1, 2020, through Oct. 1, 2024). The fee is subtracted from your loan amount, which is why the amount disbursed is less than the amount you borrowed. That said, some private student loan lenders don’t charge an origination fee. Consider Refinancing Student Loans for Better Rates Making principal-only payments isn’t the only way to lower your interest costs and/or pay off your loan early. You might also be able to do this by refinancing your student loans with a private lender, such as a bank, credit union, or online lender. With a student loan refinance, you exchange one or more of your old loans for a new one, ideally with a lower rate or better terms. This process can be helpful if you have a solid credit score (or have a cosigner who does), since it might qualify you for a lower interest rate. In addition, you could choose a shorter repayment term to get out of debt faster. You can refinance both federal and private student loans. Keep in mind, however, that refinancing federal student loans can result in a loss of certain borrower protections, such as income-driven repayment and student loan forgiveness. Because of this, you’ll want to consider the potential downsides of refinancing before making changes to your debt. The Takeaway The thought of finding extra money–beyond your required monthly payment–to pay down student debt may be daunting. However, the benefits could make it worth the effort and sacrifice. Making principal-only payments will help reduce the interest you pay over the life of your student loan. And, the more often you pay down your principal balance, the faster you’ll pay off your student loans. If you choose to make principal-only payments, you’ll want to communicate with your lender to make sure that those additional payments are applied only to your loan’s outstanding principal. This story was produced by SoFi and reviewed and distributed by Stacker.