Was there student loan forgiveness or cancellation? Did someone else pay off my debt for me? Was there a lender error that means I’m debt-free?

There are several reasonable explanations for the zero-dollar balance. In some cases, a borrower truly is free of their debt. In others, the debt moved.

When a Zero Balance Means Loan Forgiveness

The Department of Education is performing a one-time audit of borrower payment histories and giving borrowers credit for months that previously didn’t count.

For example, prior payments on the standard repayment plan, as well as some deferments and forbearances, may now get credited as progress toward loan forgiveness.

Borrowers who had their balances forgiven should receive an email from their lender. Additionally, their servicer portal should also show that the loans were forgiven under the IDR adjustment.

If you got an email and see this language on your servicer portal, congratulations!!

Sherpa Tip: The one-time adjustment is happening right now for the borrowers close to earning forgiveness. For other borrowers, it will take place in the summer of 2024.

In most cases, borrowers do not need to take any action. However, some will need to consolidate their loans by June 30, 2024.

The Disappointing Reason Your Federal Student Loan Account has a Zero Balance

Sadly, a zero balance on a servicer portal doesn’t always mean loan forgiveness.

In some cases, it just means your loans got moved to a new servicer.

Unfortunately, this is a pretty common occurrence. The federal government has contracts with several different loan servicers. Sometimes these contracts are renewed; other times, a new company gets the contract.

In some cases, only certain loans get moved. Thus, it is possible your balance dropped significantly but didn’t go all the way to zero.

Sherpa Thought: These transfers shouldn’t be so confusing for borrowers. If servicers or the Department of Education did a better job notifying borrowers, people wouldn’t be surprised to see a $0 balance.

Tracking Down Transferred Loans and New Servicers

To the credit of the Department of Education, they do a nice job helping borrowers track down the appropriate servicer.

Within the studentaid.gov website, there is a database of student loans that borrowers can access. Within this database is a breakdown of every loan and the company responsible for servicing the loan.

If I saw an unexpected drop in my federal student loan balance, studentaid.gov would be my first stop. Because navigating to individual loan information is a bit complicated, I’ve put together this guide on accessing the records.

The Public Service Loan Forgiveness Waiver

If you previously applied for Public Service Loan Forgiveness, your loans may also be forgiven.

On October 6, 2021, President Biden announced that the Public Service Loan Forgiveness rules were temporarily changed. Previous payments that didn’t count because the borrower was on the wrong repayment plan or the loans were not eligible may now count.

If you have previously applied for Public Service Loan Forgiveness or completed an Employer Certification Form, the Department of Education may have reconsidered your application.

This article breaks down the new program and rules in more detail.

Other Possibilities for a Federal Student Loan Balance Drop

A balance transfer or PSLF may be the most likely explanation, but other possibilities exist.

For example, President Biden recently announced plans to cancel $1 billion worth of student loans for borrowers defrauded by their schools. This is a continuation of an Obama-era program that was significantly limited during the Trump years.

However, it is worth noting that the borrower defense to repayment cancellation only happens to borrowers who successfully apply to have their loans canceled.

Another slight possibility is if Congress or the President chose to cancel large amounts of student debt for all borrowers. As of the date of this article, no such plans exist. Even though there is some support for massive forgiveness, it is far from a certainty. Additionally, if something like that did happen, it would be all over the news.

Preventing the Transfer to Another Servicer

Federal servicer transfers can be a significant issue for borrowers. And the problems go beyond the disappointment of learning a zero-dollar federal student loan balance just means the debt has moved.

A change in servicers can have many negative issues for borrowers:

• Payments may be missed due to auto-debit issues.
• Frequent servicer changes open the door to fraud.
• Payments may be missed because banks mailed checks to old servicers.
• Important records and communications may get lost.

Worst of all, borrowers have very little power to prevent a servicer change. If your student loans are on the move, take these steps to streamline the process and avoid issues.

The post Why Did My Federal Student Loan Balance Drop to Zero? appeared first on The Student Loan Sherpa.

Despite the multitude of reasons why a student might elect to take a gap year, the student loan consequences are generally identical for everyone.

In many cases, existing student debt doesn’t majorly impact gap year plans. Nonetheless, planning your gap year with your student loans in mind from the beginning can be greatly beneficial.

The Student Loan Grace Period and a Gap Year

All federal student loans offer a grace period of at least six months, for which students are not required to make payments. This grace period starts after a student leaves school, giving them time before they need to begin repayment. For example, if a student stops attending school in May, the student can typically expect to start making payments in November.

For private student loans, the existence and length of a grace period depend on the loan’s contract terms. Some lenders offer a shorter grace period or no grace period at all. However, in most cases, private student loan lenders align with the federal standard of six months.

This means that in a 12-month gap year, a borrower may only have to make payments for the last six months.

One important note to remember is that borrowers get only one grace period per loan. This can complicate matters for borrowers who return to school and take out additional loans. While most borrowers enter their grace period upon graduation, borrowers who took a gap year might have loans that require immediate repayment.

Another important note is that most loans accrue interest during the grace period.

Interest Will Continue to Accrue*

Borrowers looking to delay or reduce any payments required during a gap year have several options available to them.

Federal loan borrowers can apply for income-driven repayment plans, which means that a borrower’s monthly payments can conceivably be reduced to $0 depending on their income. Private loan borrowers might be able to request additional forbearance or deferment after their grace period ends, further delaying repayment.

Unfortunately, these strategies for reducing or delaying payments come with a significant drawback: the accumulation of student loan interest. Student loans accrue interest daily, increasing the total amount owed.

Taking a year off from school allows the student loan debt to grow exponentially. This is an extra cost to a gap year that borrowers should carefully consider.

However, there is one strategy that many federal loan borrowers can pursue to avoid accruing interest during their gap year.

Avoiding Interest Charges

Federal borrowers now have the option of applying to the SAVE income-driven repayment plan.

Unlike other federal income-driven repayment plans. SAVE offers a generous subsidy that covers 100% of the monthly unpaid interest. For borrowers eligible for $0 monthly payments, SAVE will cover 100% of the interest charges that would typically accrue under other plans. This means that your federal student loan balance will not increase for taking off a year and not making any payments.

It is worth mentioning that the monthly amount you owe under a SAVE repayment plan is calculated based upon your most recent tax return. Thus, if you were a full-time student when you last filed your taxes, it’s very likely you could qualify for $0 monthly payments under SAVE. This is true even if you earn some income during your gap year.

Even for those borrowers who don’t qualify for $0 per month payments on SAVE, the interest subsidy is still available. This calculator will break down your monthly SAVE payment and subsidy.

Borrowing Implications Upon Returning to School

For the most part, borrowing student loans after a gap year works just like it did before the gap year.

However, there are a couple major exceptions that borrowers should understand.

First, those who take a time off from school in order to earn extra money may qualify for less need-based aid when they return to school. This could result in fewer grants and possibly qualifying only for unsubsidized federal loans instead of subsidized loans. This is an important consideration for those thinking about taking a gap year to improve their financial situation.

Second, financial decisions made during a gap year could impact future student loan borrowing. For example, a borrower who accumulates a lot of credit card debt during their gap year travels may find it more difficult to qualify for private student loans upon returning to school. Additionally, missed student loan payments during a gap year can make qualifying for future loans far more challenging.

Avoiding financial mistakes during a gap year is one of the reasons why it is so important for borrowers to stay organized.

Tracking Student Debt During a Gap Year is Essential

If you decide to take a year off from school, dealing with your student loan servicers is something you can’t really avoid. For example, you might need to ask for an additional deferment or request lower payments; regardless, these you’ll probably have to interact with them.

Keeping up with payments and safeguarding your credit score is essential, but there’s more at stake than just that.

One harsh reality that many student loan borrowers discover is that they have no control over the company that owns their debt. Private lenders routinely sell the debt to other companies. Federal loan servicers often change.

When this happens, it can be very difficult for borrowers to know who to pay or how much they owe. Some don’t learn that their debt has been sold until a creditor calls them asking about missed payments. By that point, the credit score damage may already be done.

Given the possibility that your loan could be sold, keeping your contact information up to date with your lenders is crucial.

Updating your details with loan servicers isn’t just helping them. It’s a vital step to protect yourself. If there’s a change in the loan servicer, for example, staying informed ensures you don’t miss important updates or payments.

The Lesson: Plan Ahead

Regardless of the reason a borrower chooses to take a gap year, it is essential to have a solid plan in place for managing student loans during this time.

Borrowers should know when repayment will start, determine which repayment plans are available to them, and figure out how they will be afford the monthly payments.

Neglecting the planning stage could lead to late fees and the unnecessary buildup of interest, making the loan even more expensive in the long run.

The post What Happens to Student Loans During a Gap Year? appeared first on The Student Loan Sherpa.

The emails usually look something like this:

Dear Sherpa,

When I make student loan payments, my lender counts almost all of my payment as interest, and very little goes to the principal balance. Is there a mistake? Is my student loan company cheating somehow?

How can I make more of my payment go towards principal?

Thanks,

A Concerned Borrower

Even though there isn’t a way to get payments to count towards 100% principal, there are several ways to improve things.

Making Extra Payments

Most borrowers don’t have extra cash sitting around that they can use to pay down their student loans. However, if you can spare a few extra bucks each month to make slightly larger payments, it can make a meaningful difference.

The math is kind of crazy.

If you have a $100 per month student loan payment, over $90 per month may be charged as interest. That leaves only $10 per month to lower the principal balance. If a borrower in this situation can find an extra $10 per month to pay towards their loan, the loan will get paid off six years early and save the borrower $5,000 in interest!

Why does a little extra make such a big difference?

When you make a student loan payment, your lender first takes out the interest charges for the previous month. After the interest, the rest of the payment lowers your principal balance.

If you pay extra, 100% of the extra payment lowers the principal.

Find a Way to Get a Lower Interest Rate

If interest is eating up most of your student loan payment, the odds are pretty good that you are dealing with a high-interest loan.

I’ve previously posted about over a dozen different ways to lower your interest rate. Some of the methods are difficult, like joining the military. Others are pretty easy, like signing up for auto-debits.

For borrowers with private loans, the most common solution to a high interest rate is refinancing with a new lender.

At present, the following lenders are offering the lowest refinance rates:

Rank	Lender	Lowest Rate	Sherpa Review
T-1		4.86%	ELFI Review
T-1		4.86%*	Splash Financial Review
3		5.29%	Laurel Road Review

Unfortunately, for refinancing to be a viable option, borrowers will need a steady income and decent credit score.

What if All My Payment Counts as Interest? If your monthly payment doesn’t even cover the monthly interest on the loan, it usually means you are on an income-driven repayment plan and have a federal loan with a large balance. Borrowers in this situation should carefully consider the REPAYE plan for its interest subsidy and think about the different options for student loan forgiveness.

Focus on High-Interest Debt

Suppose you spend a total of $300 per month on all of your student loans. It is possible that getting lower payments on one loan and using the extra money on another loan can get your debt paid off sooner.

The big idea here is that high-interest debt is much more of an emergency than low-interest debt. If you focus your efforts on eliminating high-interest debt first, your ratio of principal to interest will quickly shift in a favorable direction.

In other words, if you focus on the high-interest loans first, you will pay off your debt sooner and spend less on interest.

There are a variety of federal repayment plans available. Many private lenders also offer repayment options for borrowers. If you can get a lower monthly bill on your low-interest loans, it becomes easier to attack the high-interest debt.

Don’t Miss Due Dates

Lenders don’t like to reduce principal balances. They prefer to charge interest and fees so that your debt continues to be a source of their income.

Lenders process payments in the following order:

1. Late Fees and Other Charges
2. Interest
3. Principal

If you miss a payment deadline, you may get charged a late fee. Between the late fee and the month’s interest charges, very little payment may remain to reduce the principal balance.

Consider Auto-Debits: Allowing your lender to pull money out of your bank account each month has major pros and cons. On the pro side, you may qualify for a slight interest rate reduction. It will help you avoid missing a payment. The con is that your lender has access to your bank account. Some borrowers also run into issues with auto-debits leading to missed deadlines and late fees. If you go this route, keep a close eye on your first couple of payments to make sure things run smoothly.

The Ratio of Principal to Interest Gets Better Each Month

When interest eats up most of your student loan payment, it sucks. For many borrowers, it feels like the student loan will never get paid off.

The good news is that even just a little bit of principal paid down makes a difference. A smaller principal balance means the loans generate less interest. Less interest means the ratio of student loan interest to principal shifts slightly. As time passes more and more of your payment counts towards principal instead of interest.

With each passing month, things get better.

The post Improve the Ratio of Principal to Interest on Student Loan Payments appeared first on The Student Loan Sherpa.

We frequently receive emails from borrowers who have much larger balances on their debt than what they originally borrowed. This issue is so widespread that nearly half of all student loan borrowers have an increased balance after 5 years. Sometimes, missed payments and late fees can explain the larger balances. However, in many instances, the balance increases even though the borrower has done nothing wrong.

In this article, we’ll explore why student loan balances can increase and offer strategies to prevent this from happening.

What causes a student loan balance to increase?

Borrowers making timely payments reasonably expect that their loan balance will decrease as a result of their efforts. Although multiple causes could explain why a student loan balance might increase, the following two reasons are the most common:

Growth During School – Most borrowers don’t make student loan payments while attending school. However, interest continues to accrue (except for federal subsidized loans). This leads to years of growth and compounding interest. As a result, many borrowers enter repayment with a balance significantly higher than what they actually borrowed.

Income-Driven Payments – This issue is unique to federal loans with income-driven repayment plans. Federal income-driven plans allow borrowers to make payments based upon what they can afford rather than what they owe. If the loan’s monthly interest is more than the monthly payment, the total loan balance increases with each passing month.

Other reasons a student loan balance may be increasing

Other reasons a student loan balance may increase include:

Deferments and Forbearances – Many lenders allow struggling borrowers to temporarily pause repayment. Most lenders also give borrowers who have left or graduated school a six-month “grace period” before they must begin repayment. Although no payment is due, the interest is still working for the lender, growing the loan balance.

Payments Less Than the Monthly Interest – Sometimes, private lenders allow borrowers to temporarily reduce the amount they pay each month. While this offers borrowers some relief, the interest usually continues to accumulate. These smaller payments help borrowers stay current, but they also help the lenders make some extra cash from the additional interest.

Extended Repayment Plans – Some repayment plan terms stretch out over 20 years or more. This means early payments mostly cover the interest. Borrowers on these plans are paying down their balance, but very slowly. Combined with interest accrued during school, the total loan balance often ends up higher than the original amount borrowed.

Calculation Errors – Lenders aren’t perfect. It’s possible that the lender has made an error. Mistakes are particularly common when the lender made any manual adjustments to the balance. Borrowers should keep copies of loan statements and documents so they can prove any errors. Sometimes filing a complaint with the Consumer Financial Protection Bureau may be necessary.

While several factors can cause a loan balance to exceed the original amount borrowed, there are tools and strategies available to help borrowers reduce their balances.

As you can see, there are a number of reasons that a loan balance may exceed the original amount borrowed. Fortunately, there are also a number of tools and strategies available to help borrowers reduce their balances.

Lowering the Principal Balance on Loans

Make Extra Payments – The most common and effective way to lower a student loan balance is to make extra payments. A borrower’s regular payments covers any fees, then accumulated interest, and then the principal balance (in that order). Because the monthly payment normally covers these three categories, extra payments should go entirely towards the principal. Even a small amount can make a significant difference over time.

Get Real Lender Assistance – While federal loans typically offer the best terms, some private lenders may provide relief for struggling borrowers. For example, Navient offers a Rate Reduction Program, which temporarily lowers interest rates for borrowers with unaffordable payments. Lower interest means more of the payment can go towards the principal balance.

Focus on the Highest Interest Rate Loan First – The greatest enemy to student debt elimination is interest rates. The higher the interest rate, the more difficult it is to eliminate the loan. By concentrating on paying off the loan with the highest interest rate first, borrowers can pay off their loans faster and save money in the long run. While some borrowers prefer to pay a little extra on all of their loans, it is far more effective to focus extra efforts on one single loan at a time.

Sign Up for the REPAYE Plan – Though there are many federal income-driven repayment plans, one of them has a special perk for borrowers whose monthly payments are less than the monthly interest. The REPAYE plan will immediately forgive half of the extra interest that accumulates each month. For example, suppose a borrower has loans that generate $200 of interest per month, but the borrower must pay only $50 per month. Instead of the balance growing by $150 per month, it will only grow by $75 per month on REPAYE. Switching to REPAYE won’t stop the balance from increasing, but it will slow it down.

Find Lower Interest Rates – Lenders like SoFi, Laurel Road, and CommonBond all offer interest rates below 3%. These lenders can be picky about credit approvals, so it is a good idea to shop around and check rates with many of the lenders offering student loan refinancing.

One Last Bit of Good News…

As borrowers begin repayment, student loan lenders initially apply most of the borrower’s payments towards the interest, with only a small portion reducing the principal balance. However, as the principal balance decreases, the interest that accrues each month also decreases. This means that, with each passing month, a larger portion of the same payment goes towards reducing the principal balance.

Just as setbacks can cause a student loan balance to spiral out of control, making positive progress can likewise build momentum and accelerate debt reduction.

The post Why is my Student Loan Balance Increasing? appeared first on The Student Loan Sherpa.

Interest can be so bad that in some cases, the monthly interest is larger than the monthly payment. Borrowers facing high interest rates may never miss a payment and spend thousands of dollars over the years and only see their balance drop by a few hundred dollars.

Lenders have a huge incentive to count payments towards interest because interest is how these companies generate income. However, borrowers have options that can make a larger percentage of their payment count towards the principal balance.

With less money applied to interest, student debt can be eliminated faster. In many cases, a smart strategy can make a big difference for debt elimination… even if you don’t have extra cash to spare.

Battling Student Loan Interest

Unfortunately, student loan interest is a reality in all student loans. It is how lenders and the federal government make money on student loans.

Interest typically accrues daily. With most private student loans, this accrued interest is typically added to your balance once a month.

There is no way to avoid student loan interest completely. However, there are ways to minimize interest and make sure a larger portion of your student loan payment attacks your principal balance.

Payments targeting the principal balance

Several different tactics can be used to knock down your principal balance.

Avoid Late Fees and Lender Charges – If your lender charges you a late fee or any other fee, this money becomes lender profits and does not touch your principal balance. When lenders receive a monthly payment, they usually pay down balances in the following order of priority:

1. Fees and penalties
2. Interest
3. Principal

It is important to remember that fees and interest are lender profits, while a reduction of the principal balance lowers the amount that you owe. Expect most lenders to charge fees and interest whenever possible. Making sure that you do not miss any deadlines or incur other fees is essential.

Pay a little bit extra each month – This method can be an incredibly effective method to eliminate debt. We have previously shown how as little as $10 per month can actually make a huge difference in paying off your student loans. This approach helps on two fronts. First, the extra money you pay should be applied directly to your principal balance. Thus, the more you pay, the larger percentage of your monthly payment reduces your balance. Second, as your principal balance decreases, the monthly interest charge will also go down. That means the extra payment you make lowers your balance immediately, and it makes a larger percentage of every future payment count towards principal.

Take your business elsewhere – All lenders charge interest, but not all lenders charge the same interest rate. If you have a decent job and your lender is charging you 6, 8 or 10% on your student loans, the odds are pretty good that you can get a lower interest rate elsewhere. This is because you are much less of a credit risk as an employed college graduate than you were as an unemployed college student. Less credit risk equals a lower interest rate.  There are over a dozen lenders offering student loan refinancing services.

Companies like SoFi, Splash, and CollegeAve all offer interest rates at just over 2%.

If you can get a lower interest rate, it means that your debt will generate less interest each month. By doing this, more substantial portions of your payment will reduce the principal balance. In short, the same exact payment could put a much bigger dent in your debt balance.

Ask your lender for help – This approach is a long shot, but if you are in a desperate situation, it can potentially work. The key is to understand the lender tricks that hurt, and the things lenders can do that might actually help.

Lenders are usually happy to offer a forbearance or a deferment on your student loan. This means you don’t have a bill for a few months, but it is making your student situation much worse. Even though payments stop, the monthly interest does not. Your balance after a forbearance or deferment will be much larger than what it was when it started. Along the same lines, if your lender lowers your payment, but not your interest rate, it just means you will pay more money on interest over the life of the loan.

The thing that can help is if your lender is willing to temporarily lower the interest rates on your student loans due to a hardship. We have seen some borrowers have some success with this approach.  If you are truly struggling to repay your loans and your lender will not work with you, consider filing a complaint with the Consumer Financial Protection Bureau. These complaints can force your lender to take a second look at your situation and potentially get you the result you seek.

Be sure to pick the right principal balance

If you do pay extra towards your student loans, lenders apply the extra payment in different ways. Some use the payment to lower the bill for furture payments. Others spread the extra payment across all of your loans.

Borrowers get to specify how they want additional payments processed. Have your lender put all of your extra payments towards one of your student loans. Target the student loan with the highest interest rate. Using this strategy, you will most efficiently reduce future spending on interest.

A common mistake that many borrowers make is to pay a little extra on all of their student loans. While this approach is better than just paying the minimum, it still can cost thousands of dollars due to its inefficiency.

Some lenders will also reduce the amount you owe on future payments. If you pay a double payment this month, they may say you don’t owe anything next month. Don’t fall into this trap. Lender profits are maximized when you pay the minimum. They do this to encourage you to pay less now so that they get more interest in the future.

Student loan interest vs. principal

Seeing the majority of your student loan payment go to lender profits instead of reducing what you owe can be terribly frustrating. Proactive borrowers can usually find ways to save money on interest without having to spend anything extra.

Once you understand the lender strategies to maximize profits, you can avoid traps and pay off your student loans as quickly as possible.

The post Getting Student Loan Payments to Count Towards Principal and Not Interest appeared first on The Student Loan Sherpa.

Interest accrues daily, is billed monthly, but is only added to the principal balance after certain events.

I know that sounds like a complicated mess. By the end of this article, the student loan interest timeline will make more sense, and you will understand how to use this mess to your advantage.

Student Loan Interest Accrues Daily, But it Doesn’t Get Added to the Balance

Student loans generate interest every day.

Think of it like your electric bill. Every day you are using electricity. You don’t receive a daily bill. Yet at the end of the month, you can be certain you will receive a bill adding up each day’s expenses.

Student loans work similarly. Each day your lender is charging interest. Lenders and servicers may not show it on the student loan portal, but they are tracking it.

The Monthly Student Loan Bill

Each month your lender sends out a bill listing the interest charges for the month. That number isn’t based upon a monthly rate. Instead, it is the sum of the daily interest charges.

You may notice that months based upon a 31-day bill have higher interest charges than the months based upon a 30-day cycle.

Borrowers can utilize this fact by paying their student loan bills as early as possible. Waiting until the due date means the daily interest accrual is based upon a larger loan balance. Making payments a few days early means the balance will be slightly smaller for those few days. The difference in savings isn’t significant, but for larger balances, it can add up over the course of many years.

In most cases, the monthly payment is larger than the monthly interest. Borrowers in repayment will see their balance go down with each payment.

Borrowers who are not making payments, or who make payments smaller than the monthly interest, will see their balance go up.

Compounding Interest, Capitalized Interest, and Growing Student Debt Balances

The big danger with a growing student loan balance is that it can spiral out of control.

If the balance grows, more interest is charged. As more interest is generated, the balance grows even faster. Paying interest on the interest is known as compounding interest.

Fortunately, borrowers do not immediately start paying interest on the interest that accrues daily. In fact, federal student loan borrowers don’t even pay interest on the interest that is charged on each monthly bill.

Paying interest on the interest happens after capitalization. Interest is capitalized when it gets added to the principal balance of a loan.

Outstanding interest is the term federal servicers use to track the extra interest that has not yet been capitalized. Most federal servicer portals will show a borrower’s current balance, principal balance, and outstanding interest.

It is better to have federal student debt classified as outstanding interest because there isn’t a daily interest charge. Once capitalization happens, and the outstanding interest gets added to the principal balance, borrowers start paying interest on the interest.

As a result, interest capitalization can be very expensive for federal student loan borrowers. It is possible that a borrower could go years without having their loan capitalized. If an event triggers a capitalization, the principal balance could easily jump by thousands of dollars.

Avoiding Interest Capitalization on Federal Student Loans

In some cases, interest capitalization is unavoidable.

A common example of unavoidable interest capitalization is a borrower entering repayment after college. Federal direct consolidation also triggers interest capitalization.

Other times, responsible borrowers can avoid interest capitalization. For example, if you are on an income-driven repayment plan and miss your income certification deadline, you are automatically enrolled in the standard repayment plan. Changing repayment plans triggers interest capitalization. Thus, for borrowers on IDR plans, missing an income certification deadline could be very expensive.

Borrowers concerned about interest capitalization should review this article on avoiding capitalized interest on federal student loans.

Interest is the Enemy of Student Loan Repayment

The fight against student loan interest often leaves borrowers with two main strategies to efficiently eliminate their debt.

The borrowers who have increasing balances because they cannot keep up with interest should investigate the many options available for student loan forgiveness.

The borrowers knocking out their debt and fighting the daily interest should explore the strategies to get a lower student loan interest rate.

The post When Does Student Loan Interest Get Added to My Balance? appeared first on The Student Loan Sherpa.

Knocking out a student loan balance in full is a dream come true for many borrowers.

As the dream starts to become a reality, fear sets it. Am I making a mistake? What is the downside to sending in that final big check to pay off my student loans?

Before spending thousands of dollars on anything, it is a good idea to double-check your decision. In the case of a final payoff of student loans, most borrowers will find that the pros of a final massive payment outweigh the cons of debt elimination.

However, it is worth looking at the potential negatives to paying off your student loan because it is a big decision. Once you understand the possible consequences of your choice, it becomes much easier to move forward.

The Main Downside to Paying Off a Full Student Loan Balance

If you have hundreds or thousands of dollars sitting in your bank account, that money probably isn’t earning much interest. Meanwhile, your student loan is generating interest for your lender every day. Making a big final payment means interest stops working against you.

Unfortunately, in addition to giving up a bunch of money, you are also giving up flexibility. In your bank account, that money can be used for anything. Once the money goes to the lender, it is gone forever. Borrowers should think about what would happen if they lost their job, had medical bills, or ran into another unexpected expense.

People with debt, even those with high-interest loans, should still maintain an emergency fund. The size of an emergency fund for student loan borrowers will depend upon several circumstances. However, the constant is that everyone should have an emergency fund.

Completely emptying your bank account to make a final student loan payoff could be risky.

A Tiny Concern: The Student Loan Tax Break

In the interest of making sure nothing gets overlooked, we should discuss the tax consequences.

There is a student loan interest deduction available to all borrowers. However, losing a small tax break isn’t much of a downside to paying off the full student loan balance.

The tax help for student loan borrowers comes as an interest deduction. Payments towards the principal balance do not trigger any tax relief. As a result, many borrowers only get to deduct a small portion of their student loan payments.

Additionally, it is a deduction rather than a tax credit. If you spend $700 on student loan interest, you don’t save $700 on your taxes. Instead, the government will tax you as though you made $700 fewer dollars that year. If you are in the 12% tax bracket, spending $700 on student loan interest will save you $84 at tax time.

In short: yes, you lose your student loan interest tax deduction. No, it isn’t much of a concern.

Can I negotiate a discount by paying the loan off in full?

Some borrowers may think that they can negotiate a break by making a large final payment.

Unfortunately, this is rarely the case.

Lenders know that borrowers are contractually obligated to pay off the entire student loan balance. They will not be inclined to offer a discount to someone following the terms of the agreement.

In some limited cases, borrowers may be able to negotiate a reduced final payment. However, these instances usually only apply to borrowers who have struggled to the point the lender fears they may not ever receive payment in full.

Thus, missing out on the chance to negotiate isn’t much of a concern in making a large student loan payment.

Opportunity Costs: A Con to Consider

In economics, an opportunity cost is the loss of a benefit because of a decision you made.

For example, if you make a large payment towards your student loans, you miss out on the opportunity to put that money into a retirement account.

The larger the final student loan payment, the higher the opportunity cost.

Borrowers should consider their other financial goals before making the big final payment. These other goals might include:

• Buying a house,
• Saving for retirement,
• Having children, and;
• Starting a business.

The opportunity cost will vary from one borrower to the next. However, all borrowers should consider the missed opportunities as potential downsides to paying off a student loan balance.

Finding a Middle-Ground Alternative

If your student loan interest rates are brutal, but sending in the big check sounds too scary, there is a middle-of-the-road approach.

Borrowers that refinance can lower their student loan interest rates and keep their money in their bank account.

For those not familiar, in a refinance, a new lender pays off your old student loans. A new loan is created that gets repaid to the new lender. The process works because the refinance companies targets low-risk borrowers. As a result, they can charge a lower interest rate and still make a profit. As someone with enough cash set aside to pay off a loan balance in full, you probably fall into the lower risk category.

Going the refinance route can make living with student loans a little bit more bearable. It can also allow for maintaining an emergency fund or saving for retirement.

Most borrowers will lean towards just getting rid of their student loans, but for those truly on the fence, refinancing could be the best of both worlds.

At present, the following lenders are advertising the lowest interest rates on student loan refinancing:

Rank	Lender	Lowest Rate	Sherpa Review
T-1		4.86%	ELFI Review
T-1		4.86%*	Splash Financial Review
3		5.29%	Laurel Road Review

The post The Downside or Danger to Paying Off Student Loans in Full appeared first on The Student Loan Sherpa.

It is also a source of confusion for many borrowers.

This confusion is a significant problem for two reasons. First, loan servicers do a horrible job preventing capitalized interest issues and explaining the consequences. Second, not understanding capitalized interest can cost a borrower thousands of dollars.

The Basics – Why Capitalized Interest Matters

Student loans generate interest daily. However, that interest isn’t added to your principal balance immediately. When you make a payment, the accrued daily interest is paid first. Then the remainder of the payment reduces your principal balance.

If you are on an income-driven repayment plan, such as IBR or PAYE, the monthly interest on your student loans may be larger than your monthly payment. When this happens, the interest balance actually grows each month, but your principal balance stays the same. Similarly, if you are in school or on a deferment or forbearance, interest continues to accumulate while principal balance doesn’t move.

Interest is “capitalized” when it is added to your principal balance. This is a significant event because you are now paying interest on a larger balance. This accounting shift can end up costing a borrower a ton of money.

An Example of the Risk of Growing Loan Balances

Suppose you have $100,000 in student loans at an 8% interest rate. Those federal student loans will generate $8,000 per year in interest. If you are on an income-driven repayment plan, and your monthly payments are $250 per month, you are only paying $3,000 per year towards your student loans. Your balance is growing by $5,000 per year.

If your interest is not capitalized, your loan will continue to generate the same $8,000 of interest each year. However, suppose after five years of this, an event triggers interest capitalization of the federal loans. The $5,000 of unpaid interest from each of the previous five years gets added to the principal balance. As a result, your principal balance is now $125,000.

The following year, the interest generated by the loan is not $8,000. Instead, it is $10,000 (this number is the $125,000 times the 8% interest). In short, the cost of capitalized interest in this example is $2,000 per year.

Avoiding Federal Student Loan Interest Capitalization

Given how expensive interest capitalization can be, preventing these events is an important goal. Many of these events are unavoidable. However, with some planning, expensive triggering events can be eliminated.

The following events can trigger interest capitalization:

• The loan entering repayment at the end of school
• A loan deferment or forbearance ending
• Federal direct consolidation
• A change in repayment plans
• The loan going into default

Going back to our original example shows the importance of timely submission of your paperwork for your yearly income certification. Missing a deadline means the borrower is placed back on the standard repayment plan. This change in repayment triggers interest capitalization. Don’t miss an income-certification deadline!

New Rules Help Borrowers Avoid Capitalized Interest Charges

When the Department of Education announced the new SAVE plan, they also announced some changes to help borrowers avoid capitalized interest charges.

First, the Department of Education will only capitalize interest when required by statute. This is good news, but it is also potentially confusing. Interest will capitalize if you switch from the IDR plan because it is required by statute. However, it isn’t required when switching from REPAYE, so interest won’t capitalize in that situation.

Second, the REPAYE/SAVE subsidy now covers 100% of the monthly unpaid interest. Borrowers on this plan won’t have unpaid interest accumulating, so they won’t have extra unpaid interest that could capitalize.

Third, thanks to some new legislation, the Department of Education can now get permission from borrowers to automatically pull IRS records each year. Borrowers who authorize the automatic process will be able to ensure income certification deadlines are met.

An Essential Reminder for Borrowers with Large Federal Balances

A critical concept in student loan literacy is the capitalization of unpaid interest.

If you have a large loan balance and your monthly payment is less than the monthly interest, it is critical to avoid events that trigger capitalization.

The post Federal Student Loans and Capitalized Interest appeared first on The Student Loan Sherpa.

The key to effectively and efficiently managing student loan repayment is to minimize the amount spent on interest and maximize payments toward the principal balance.

Borrowers who understand how interest is charged are better-positioned to identify any lender errors and to pay off their loans more quickly. Here, we will explore some of the tricks and strategies that borrowers can use to reduce interest spending.

Student Loan Interest Basics

Payments made towards interest do not reduce the loan balance. Rather, those payments are how lenders generate profit.

Accordingly, it should come as no surprise that most lenders try to structure repayment in a way that maximizes the portion of payments that apply towards interest while minimizing that which reduces the loan balance.

Student loans generate interest daily. Accrued Interest is the total amount of interest that has built up over time on the loan. Interest Capitalization occurs when the lender adds that accrued interest to the principal balance.

When lenders send the bills each month, they usually show the accrued interest added to the balance. This might give some borrowers the impression that lenders are capitalizing interest once a month. However, borrowers should understand that their loans are actually accruing interest daily.

Once the loan balance includes the accrued interest, lenders can then charge interest on that new loan balance. This concept of paying interest on the accrued interest is known as compound interest. Student loans accrue interest daily, but typically compound monthly.

Processing Payments: Interest, Fees, and Principal

The objective for any borrower should be to reduce the principal balance. When the principal balance is paid in full, the loan is eliminated.

Because lenders prefer to apply payments towards interest rather than the principal, lenders typically prioritize payments in this order:

1. Fees – If the account has any late fees or any other fees, the lender applies the payment here first.
2. Interest – Any unpaid interest associated with the account is next paid in full.
3. Principal* – The lender applies the remainder of the payment to the principal balance.

* Some lenders like to employ “creative” methods with this portion of the payment. Borrowers who pay more than the minimum do so because they want to knock down the principal balance. Ideally, the extra payment would count 100% towards reducing the principal balance.

Unfortunately, some lenders, such as Sallie Mae, apply the overpayment to the amount due on the next billing statement. For borrowers trying to pay off their loans as fast as possible, this can be a significant headache. It can also create a temptation to pay less in future months. Plaintiffs in a class-action lawsuit against Navient highlighted the issues with this practice. Though the plaintiffs ultimately dismissed the lawsuit, the handling of overpayments is something that borrowers should monitor.

For borrowers facing this issue, the best approach is to explicitly instruct their lender to apply any extra payments towards the principal, not towards future payments. This ensures that extra payments have the desired impact of reducing the loan balance more quickly

Does student loan interest compound daily?

A common misconception about student debt is that the interest compounds daily. With most loans, interest accrues daily. However, this interest is usually added to the principal balance only once per month. Thus, the interest can be said to compound monthly.

Student Loan Interest Calculations

Calculating the accrual of interest on a student loan is relatively simple. Borrowers can do this calculation manually or using an interest calculator.

To calculate interest manually – To determine the student loan’s daily interest, take the loan balance, and multiply it by the interest rate. Then divide by 365. For example, a $10,000 loan at a 5% interest rate would generate $1.37 per day of interest. ($10,000 * .05 / 365 = $1.37)

To calculate the interest online – There are many interest online calculators. This calculator makes the process simple and is ideal for estimating interest generated in a day, a month, a year, or over the life of the loan.

Does student loan interest accrue during school?

Many student loans come with special rules for students who are still in school. With the notable exception of a federal subsidized loan, student loans do accrue interest during school.

Student Loan Interest Rates

The interest rates on student loans vary from loan to loan. While some loans have interest rates that can fluctuate over time, other loans’ rates remain constant. These terms are set when the borrower signs the loan contract. Fortunately, there are a few strategies for reducing student loan interest rates.

Generally speaking, when the interest rate of a loan suddenly goes up, it is because it is a variable-rate loan. These loans are tied to an index, such as LIBOR, which banks use to determine the interest rate when lending to other banks. Variable-rate loans typically change quarterly (four times per year), but the rate may move monthly or yearly depending upon the original student loan contract. When the interest rate increases, this may lead to higher monthly payments. However, most lenders do not have an obligation to tell borrowers if their rate has gone up.

Many factors can impact the original interest rate. For example, Congress sets the rates of federal government student loans. For private loans, factors such as borrower credit score, economic conditions, and lender cashflow can affect the interest rates offered.

Lenders are rarely willing to negotiate a lower interest rate, but there are other ways to get a lower interest rate. Not everyone can turn their good credit score into a lower rate by refinancing, but programs also exist for borrowers struggling to repay their debt.

Exploring all available options to reduce your interest rate can significantly impact the overall cost of your loan and your monthly payment obligations.

Preventing Student Loan Interest Accrual and Interest Compounding

Aside from fully repaying a loan, it is nearly impossible to prevent interest accrual. There are exceptions, however. For example, federal subsidized loan borrowers who qualify for a deferment can avoid future interest accrual. Federal student loan borrowers undergoing cancer treatment may also qualify for a suspension of interest charges on their loans.

Preventing interest compounding, or capitalization, is straightforward. As long as a borrower makes monthly payments that are larger than the monthly interest, the loan balance will not grow, and the borrower will not have to pay interest on the interest that accrues each month.

For some federal loan borrowers, however, preventing compounded interest can be more complicated. Federal borrowers on an income-driven repayment plan often make payments that are less than than the monthly interest accrual. These borrowers can take steps to prevent or limit compounding interest by trying to avoid the events that trigger interest capitalization.

The most effective strategy to mitigate the impact of student loan interest is to secure a lower interest rate. We have identified a number of different methods borrowers can use to lower their interest rates. Doing this can significantly lessen the financial burden of accruing interest over the life of a loan.

The post Understanding Student Loan Interest Accrual, Compounding Interest, and Lender Math appeared first on The Student Loan Sherpa.