While studying, classes, exams, football games and partying define a great deal of the college experience, your student loans are invariably one of the last things you’re probably thinking about during those four years of undergrad.
Even if you wanted to pay off your loan early, it’s often just too difficult to commit to those loan repayments in full when you’re still a starving student.
That doesn’t mean you have to wait until graduating to begin chopping away at that debt, no matter how large or small the balance. If you started paying down the interest on your loans while you’re currently still in school, you could save some serious money down the road.
In fact, it’s such a smart move that it should instantly qualify you for your college degree – but then, you wouldn’t need to attend any classes or borrow any student loans. So, in the meantime, keep reading to see how to go straight for your interest payments to save some cash.
How student loan interest capitalizes
Student loans are just like a car loan or mortgage. There’s the total amount of money borrowed for your college tuition, called your principal amount. A standard student loan repayment plan is usually 10 years, and during that time, interest charged by your lender will begin to accrue and build on top of the principal you owe.
On the first day of freshman classes, interest begins capitalizing on your student loan balance. If you’ve got a subsidized loan granted on the basis of financial hardship, the federal government will pay your interest for you while you’re in school or during periods of temporary loan deferment.
If you have an unsubsidized loan, that means you’re responsible for all the interest that capitalizes on it. You’re allowed ample time to start making payments: you can hold off for all four years of school, plus an additional six months after graduating called a grace period. With private loans, there is no grace period: your total balance is all on you starting from graduation day.
Regular v.s. interest-only payments
The average in-state public college tuition is about $9,410, according to College Data. At four years of undergrad study, your tuition will total roughly $37,640. To keep things simple, say you have a series of unsubsidized Federal Direct Loans you’ve borrowed to cover the costs at the current fixed interest rate for unsubsidized loans, 3.76%.
Wait until graduation and after that grace period to begin making regular repayments, and your loans will have capitalized interest, every month, multiplying for 54 months – money that you’ll now owe, in full.
Here’s a simplified example: barring fees and other ancillary expenses, say your average tuition is the annual $9,410 we mentioned above. With a 3.76% APR attached to the loan, that comes to about $353 of interest in your freshman year – about $30 a month. (Actual loans are more complicated than this, but let’s keep this simplified for now.)
If you leave your payments alone until after you’ve graduated, that rate will capitalize and compound on top of itself, and the monthly/yearly interest owed will keep increasing. But aim to pay that minimum $30 a month while you’re enrolled in school, and you prevent the 3.76% rate from affecting your principal. One plan of action could be to make a $30 payment per month in your freshman year, then increase it bit by bit as you go. The exact number will depend on your specific loans, so make sure you stay informed.
Manage to make payments each month, without fail, in your freshman, sophomore, junior and senior years, and by the time you graduate, you’ll owe only the original principal amount. Even the smallest efforts – like paying half or a quarter of your interest – make the biggest difference.
4 tips to stay the course
Remember that every little bit counts. Paying just a little bit in student loan interest each month – even if you don’t start until senior year – still reduces your total debt more than if you began paying your loans after graduation.
Develop a budget. You should be building a college budget for your other expenses, like gas (if you commute), school supplies, or rent and groceries (if you live off campus). Incorporate your student loan interest payments into the mix, and use a student loan or budgeting calculator to comfortably fit them into your finances.
Earn some extra cash. Skip the Starbucks, or become a human guinea pig by participating in clinical trials for cash as ways to generate extra income. When looking for internships or looking for job opportunities, seek out paid or stipend-driven opportunities. The savings you generate can all count towards your interest payments.
Think about consolidation/refinancing. Regardless of the amount of student loan interest you’ve paid down by graduation, consider refinancing or consolidating your loans. Obtaining new repayment terms and interest rates can reduce the amount of interest you owe and make it easier to pay down your loans while avoiding the risk of debt.
How the interest-only repayment plan pays off
1. It saves you money in the long run
Paying off your interest early prevents it from capitalizing on the principal of your student loans, so you’ll owe less money after graduation. By paying down your interest first, you’re effectively separating it from your principal. So, when it comes time to pay your principal, your monthly loan payments will be cheaper than if you’d let interest build upon it, maximizing the savings on your loans in the best way possible.
2. It's obligation free
Not only is an interest-only repayment plan a smart, strategic way to get around owing more on your student loans, it’s totally at your own discretion. It’s a plan designed by you to get ahead on your loans and make them as affordable as possible. Miss a month here or there, and it won’t send you into debt. In fact, every little bit you can devote to your loan interest will keep you further away from debt. And that doesn’t take into account extra income you might earn through a new job or other opportunity; putting any windfall you receive towards your student loan interest helps chip away at your balance and resolves your debt sooner than later.
3. You'll improve your debt-to-income ratio
Any effort, big or small, to reduce your outstanding debt lowers your debt-to-income ratio, the overall percentage of your earnings that goes towards paying debt. The higher your "DTI," the more it can lower your credit score, since it gives lenders the impression that you carry more debt than you can afford. The lower your DTI, the better your chances are of being approved for low-interest lending products in the future. Even $25 or $30 a month to your student loan interest can make a difference in securing an auto loan or an apartment in the future.
4. It gets you in good financial shape
Paying down student loan interest helps you avoid the three Ds of student loans: Delinquency, Default and Debt. Start paying down your student loan interest while you’re in school, and you set yourself a precedent of developing good financial habits for the future. Dedicate a student loan interest payment each month and set a place for it in your monthly budget. When it’s time to pay down your principal, you’ve already been at it for years. Compare that to the student who waited until graduation to tackle their loans, and they’ve got their principal and interest to contend with. They’re a loan repayment newbie while you’re a pro.
2 drawbacks to interest-only repayment
1. You could lose out on beneficial tax breaks
Nobody will argue about getting some relief come tax filing time, and your student loans are no exception. Your student loan interest is tax deductible, leaving you with a bit of a dilemma – do you pay down your interest early, or wait for the tax break? According to the Internal Revenue Service, you can only deduct up to $2,500 in student loan interest annually, which only saves you a few hundred dollars a year. In the long run, you may save more making interest payments than the IRS could return to you.
2. It can become a financial burden
No matter how small a monthly student loan interest payment may be, it’s still an additional expense that can be difficult for many students on a budget to meet. It may require you to readjust an already tight budget and make financial concessions that can prove challenging for any student without a regular income.