Is it better to pay off interest or principal on student loans?

Svetlana November 11 2021

Paying off the principal amount and interest on your loans is significant. You might wonder, is it better to pay off interest or principal on student loans? This article will guide you on the matter. 

Student Loan Principal vs. Interest Payments

The principal amount is the actual amount that you borrowed from your lender. The interest is the amount of money that you pay as a fee for borrowing the money. The cash you pay back in fixed installments goes towards three things: 

  • Loan fees - a portion of repayment plans for student loans goes towards payment of fees and interest.
  • Interest fees -  a portion of the repayment plans for loans goes towards paying interest fees.
  • Principal repayment  - a portion of the repayment plans is used to pay back loan principal.

Here’s the catch. If you pay less than your usual payment plan requires you to, the money will go towards the loan fees and interest. In short, you'd be paying only the loan fees and the interest on the loan but not the principal amount.  This is the gist of what is it better to pay off interest or principal on student loans?

The thing to notice here is that you are responsible for paying your loan. Lenders aren’t responsible for any costs incurred because of your decision. For instance, if you decide not to pay extra money on the loan, you are bound by law to continue making monthly payments with your lender.

You have no choice but to adhere to this rule since there are consequences if you don't follow it. Still, most lenders do allow flexible repaying terms so be sure to check with your lender first before deciding on how much money should go towards what and when. 

The longer you take in repaying a loan, the more expensive it will become since the interest fees are higher on loans with longer repayment terms.

If you pay more than the decided amount to repay the principal sum, you must let the lender know. Otherwise, they might consider it as your next month's loan fees and interest payment. This means it's crucial that you inform them. 

Types of Loans 

Learning about the types of loans can help you choose the right option for you. 

Federal Direct subsidized loans 

If you get a federal direct subsidized loan, the government will pay your interest until you complete your degree. Once you graduate from college, you'll get a six-month grace period in which you can find a job to repay your loan. This loan option offers a fixed interest rate. 

Federal Direct unsubsidized loans 

This type of loan doesn't provide you with the privilege of the Department of Education paying your loan interest. You must make monthly payments while studying in college. If you choose not to pay while in college, the entire interest would add up in the principal amount. You don't get a grace period when you graduate from college.

 Federal Direct PLUS loans

These loans do provide a fixed interest rate but, you will not get any grace period in-between. You would have to make payments immediately, or the accumulated interest would add up to your loan. 

Private student loans 

With private loans, you don't get a fixed interest rate. Also, other terms vary as well. You would have to pay the interest during your college years. If you can't pay right away, you might ask for a deferment like in unsubsidized and direct plus loans. 

However, you have to offer proof of exceptional circumstances as a reason behind why you couldn't pay. Also, if you default on payments or refuse to pay for certain reasons, it will be very difficult to get the loan settled without being fined.

How do All These Work?

When deciding how much should go towards what and when it’s essential that you know how student loans work.  The first thing is finding out about your interest rate I.  

This information can help you decide whether or not the lender will allow flexible repaying terms like indirect subsidized and unsubsidized loans (flexible repayment terms mean low interest). Then choose the percentage amount that would go towards borrowing fees and interest f, compared to the principal amount p.

You should also know about the rules of deferred payments D, fix term t, and payment schedule f. If you don't pay during your college years, the whole interest would add up in the principal amount. This means that it's crucial that you set a payment date after you look into all these details.

Is It Better to Pay Off Interest or Principal on Student Loans? 

No matter what loan option you opt for, repaying the principal amount can help you get rid of your loans quickly. Why? Because you don't have to worry about extra interest charges. This means it can help save more money in the long run.

However, if the lender doesn't allow flexible repayment terms and requires that you pay during college years, you might end up paying more than what the loan is worth. If your goal is to repay as much as possible by a certain date, then focusing on repayment of principal sum could be useful.

Still, most lenders do offer flexible payment options. So this decision becomes easier since you can decide on what to pay after checking with them first. Also, consider other factors like the interest rates and flexibility of repayment terms while making your choice.

You can also feel free to ask for some guidance from friends or family members who have gone through the same situation. And remember that paying off principal can be useful but it isn't always applicable to all loan types.

There are two ways you can use to pay the principal amount faster

Pay more than the required amount. You can tell the lender to cut down your principal amount. By doing this, your interest rate will reduce as well. 

Pay the interest while being in college. Any other loan besides the federal subsidized loan would collect your interest and add it to your original amount. So, make monthly payments to pay off your interest. That way, after you graduate, paying the principal amount would be easier.

Other considerations when paying off the principal

Remember that your payments don't necessarily have to be monthly. Some loan providers allow you to pay off the principal twice or even three times per year. However, with this method, you are increasing the amount of money being paid in interest because now more time is being taken for paying it off.

So just make sure that you can afford to do so before choosing this option over-slicing down the repayment period.

Other than reducing your payment periods, there's another way in which you can reduce your interest rate: by paying the entire sum in two installments with a one-year gap. For example, if your loan is $25000 and you decide not to use any flexibility in repayments, then it will take up to 120 months to repay it.

In this case, if you spend two years without making any payments at all, then your interest rate would increase dramatically. This means that the monthly payment amount will be higher. However, if you pay off the loan in 24 months instead of 120, your interest for each month will be lower and you won't have to worry about high amounts along with compound interest.

General pieces of advice on how to pay down the loan faster

Here are a few tips that can help you pay off your loan in a shorter time.

If possible, try to negotiate the terms of your loan. These days, most lenders do offer flexible repayment plans since they want their customers to be satisfied. Also, it's easier for them if they know when exactly the loans would be paid back. So, find out which repayment schedule will suit you best and make sure to stick with it.

In case you have multiple student loans, prioritize paying back each one of them. It might seem like a daunting task but by doing this you can save more money in the long run. That is because different types of student debt have different rules on how much interest rates change per year and when to start adding interest in the principal. 

Don't wait for your student loan to be due before you pay it off. And never miss a payment date. It's better to pay early than have to deal with any type of charges or penalties. However, make sure that your lender doesn't charge extra fees if you need to make an extra payment beyond your usual schedule.

If possible, request an interest rate reduction. Some lenders do offer this option but usually, they would require some past-due payments before making this decision (although not always the case). If the terms are set fairly and can provide potential savings, then it is worth asking about the possibility of lowering your interest rates. This will save you even more money since you wouldn't have to pay extra interest.

Lastly, consider consolidating your loans. This will allow you to make one payment per month instead of 5 or 6 payments. You can also reduce the interest rates since now you are paying less money per month.

Yet, before repaying through this method, check with the lender first to see if they offer lower interest rates for consolidated debts. That is because some lenders don't allow this option because it reduces their profit potential.

Conclusion

If you're a student and got into debt to finance your education, then paying off your loans should be one of the top priorities on your list. On the other hand, if you really want to pay off as much money as possible, slicing down the interest rate will always be beneficial.

This is because interest rates increase with each passing year and this trend cannot be reversed. However, remember that repaying the principal amount is better than repaying only the interest since it's just like throwing money away.

Nevertheless, paying extra charges and penalties can also put a dent in your wallet so it's best if you don't miss any payment dates or else pay them off ASAP.