It is typically best not to worry about things beyond your control. For college students, however, the dizzying cost of higher education and the financial pressure placed on students’ backs by hefty student loan packages are impossible to ignore.
Students forced to take out sizable loans can only make the best of a bad situation. One step students can take is to give detailed instructions to their lender, either federal or private, to send any payments they make beyond their monthly obligation to their loan with the highest interest rate.
Most of the time, students are obligated to take out multiple loans to pay for their four-year education. The interest rates on these loans can vary from year to year.
If you have a private lender, such as Sallie Mae, and you choose to pay more than you owe in a given month, the company will proportionally disseminate that cash across all your outstanding loans. This means, in most cases, it will get divided evenly among all your loans.
Dictating to your lender that all extra payments should go toward absolving the debt principal of a specific loan allows you to pay off your highest-standing obligation first, potentially saving a great deal of money on interest payments.
If you owe an unsubsidized loan, that loan accumulates interest while you are still in school. After graduation, there is generally a six-month grace period in which to pay off the accumulated interest.
However, if you do not pay off that interest, whatever balance remains is added to the principal, or the original amount borrowed. This new total is then the one that accumulates interest, which means the overall amount required to pay off the loan goes up.
For example, let’s say you take out a one-year unsubsidized student loan of $100, with a two percent interest rate.
If at the end of the sixth-month grace period you don’t pay off the interest, all two dollars of it, will be rolled into your principal.
So now, you’re paying interest on $102 instead of $100, meaning your monthly payments will increase over the life of the loan.
For students holding outstanding debt, especially those closer to graduation, paying off specific, high-interest loans early is an effective maneuver to save money.
It is worth noting that on a subsidized loan, none of this applies. The taxpayers have picked up the tab on the interest. However, most students have to take out both subsidized and unsubsidized loans, said Nancy Coolidge, coordinator of government relations at the University of California Office of the President.
Moreover, a federal policy put in place over the summer pegs interest rates on both subsidized and unsubsidized loans to financial markets, meaning they will likely rise in the coming years as the economy picks up. For future students, making wise choices about loan payments will become especially important.
The most significant downside to directing payments is the headache it likely comes with. The complexity of loans means that it can be difficult to specify exactly what you want done with your money.
For private lenders, interest on loans tends to make up a significant portion of their profit, so resistance is expected.
However, the best remedy to these problems is patience. Debt is an unfortunate reality, but aside from lobbying Congress for lower federal interest rates, directing your payments where they will do the most good is the most immediate and plausible way to reduce your overhead.
Students do not have control over the interest rates that banks and the government set on loans. But they are our finances, and by simply managing them correctly, we can reduce the burgeoning debt burden with which we are faced.