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Repaying student loans early: How to do it right

Amy Fontinelle

Posted on May 10, 2022

Amy Fontinelle is a personal finance writer focusing on budgeting, credit cards, mortgages, real estate, investing, and other topics.
Repaying student loans early

Paying off debt ahead of schedule is one of the best ways to increase your net worth in the long run. Unlike investing, your rate of return is guaranteed: It’s equal to the interest rate on your loans. If you owe $1,000 at 10 percent, paying it off today instead of over the next 12 months means you’ll save about $100 (before inflation). You’ll also free up the monthly cash flow that was going toward your loan payments.

The good news about speeding up the date when your student loans will be gone forever is that student loans have no prepayment penalties. The bad news is that if you don’t know your lender’s typical method for applying extra payments, you might not make any progress toward an early payoff date. Here’s what you need to know to prepay your student loans the right way and unburden yourself from debt sooner.

Payments go toward late fees and accrued interest first

Typically, student loan servicers — the companies that handle your payments — first apply your payment to any late fees you’ve incurred, and then to accrued interest, before they apply anything to your principal. Accrued interest is the interest that has accumulated on your loan since your last payment. Principal is the sum you originally borrowed. (Check out how Navient and Nelnet, two of the nation’s largest student loan servicers, apply payments depending on your loan type.)

Interest can also accrue differently depending on whether a loan is federal or private. Federal student loans accrue interest based on a simple daily interest formula, where interest is charged only on principal. Private student loans usually accrue interest based on a compound interest formula, where interest is charged on both principal and outstanding interest.

The compound interest formula means interest accrues faster and your loan is more expensive, which means you’ll save even more by paying it off early.

Right after your regular monthly payment is applied, your accrued interest is $0. This is the ideal time to make an extra payment because your lender will have to apply all of it toward principal. And the lower your principal, the less interest you’ll accrue going forward.

The reality is that you might accrue a day or two of interest between the time you make your monthly payment and the time you make your extra payment. Don’t sweat it.

Here’s what you do want to worry about.

What servicers prefer

Andrew Josuweit founded Student Loan Hero, a website that helps borrowers learn how their student loans work and how to manage them better. He learned about repaying student loans the hard way: he once had 16 student loans that had ballooned to $107,000.

“When you make an extra payment, there are two options,” Josuweit said in an interview. “Your payment can be applied to a future payment. For example, if your payment is $250 a month and you make a $100 payment, that $100 is applied to the next payment. So, when your due date rolls around, your bill will be $150. This is the default, and it will prevent you from paying off the loan faster.”

When your loan is paid ahead, you might not have to pay anything for a month or more to stay current on your loans and avoid late fees. But the total number of months it will take until your loan is repaid won’t change, and the total amount of interest you have to pay before your loan is repaid won’t decrease. Applying extra payments this way is in the lender’s best interest, because it maximizes how much interest they collect on your loan. It’s definitely not in your best interest.

Here’s the second way a lender can apply your extra payment: it goes toward your loan’s interest and principal (ideally, mostly principal, as described above) rather than going toward your future payments.

“The only way to ensure your money goes to the principal is to make sure your payment is large enough to pay off the interest,” Josuweit said.

Tell your lender how to handle extra payments

The servicer’s payment processing system might be set up to automatically apply extra payments as prepayments or to automatically apply extra payments to your lowest-interest loan first. You want them to apply the extra payments to reduce your balance and put the money toward your highest-interest loan first.

If you pay online through the servicer’s website, you might have the option to choose at the time of payment how the money gets applied. But if you pay by check, by online bill pay, or through auto debit (which many lenders encourage by offering a slight interest rate discount), the Consumer Financial Protection Bureau (CFPB) says you need to establish a standing instruction on your account detailing how you want extra payments applied.

If you don’t, you’re likely to have problems. The CFPB receives thousands of complaints about student loan servicers each year, including complaints about extra payments not being applied the way borrowers expected.

The CFPB provides a sample template so you don’t have to come up with instructions on your own and worry that you aren’t getting them right. You can alter the template to fit your specific situation.

Submit one copy to your lender and keep one for your records. Make sure your servicer acknowledges receipt of your instructions; follow up if they don’t.

The default application of extra payments is not consistent between servicers, said Elaine Rubin, director of corporate communications at Edvisors®, a company that provides free advice about paying for college. Rubin has more than 10 years of experience working in higher education finance, seven of them with the U.S. Department of Education’s office of Federal Student Aid. She explained that some servicers will pay the loan ahead — applying your extra payment toward future payments — while others will apply it to the outstanding principal balance.

If you’ve already made extra payments and you aren’t sure how your servicer has applied them, check how much you owe for your next payment and when your next payment is due. If you owe less than usual or if your next due date is more than a month in the future, your servicer has used your extra payments to advance your due date — which won’t save you money unless you keep paying the usual, full amount each month. That’s because your principal balance is always accruing interest between payments.

Apply extra payments strategically

Do you have more than one student loan? If so, there are two ways to strategically apply your extra payments: the snowball method and the avalanche method.

For some people, the psychological advantage of getting the smallest loan paid off first, then moving on to the next smallest loan, and so on — the snowball method — makes them feel like they’re making progress and provides more motivation to stick to a plan for repaying student loans early.

But the option that will save you the most money is the avalanche method, which knocks out loans starting with the highest-interest-rate loan and moving toward the lowest-interest-rate loan. A student loan prepayment calculator can help you decide which plan of attack you’d prefer.

What you definitely don’t want is for your extra payments to be spread thin and applied across all your loans. You’ll make progress too slowly this way. Instead, you want to pay the minimum on every loan except one. Direct all your extra payments toward the smallest-balance loan or the highest-interest loan. You may be able to do this online through your lender’s website, or you may need to specify your preference using written instructions like the ones provided above.

Keep a close eye on your statements

Unfortunately, it’s not enough to give your servicer payment instructions and faithfully make your extra monthly payments. You have to check on your loan servicer to make sure they’re actually following those instructions by examining your statements carefully each and every month.

“Borrowers complain that when they make extra payments on their loans and include instructions for payment application, their servicers disregard their instructions, or only follow the instructions intermittently,” the CFPB noted in its latest annual report addressing the issue. “Other borrowers complain that after making extra payments on their loans, their servicer may re-disclose the loan, thereby lowering the monthly payment and extending the loan terms, but also increasing the overall cost of the loan.”

Redisclosure can happen when your loan gets transferred from one servicer to another — a common practice — or when a servicer changes its computer systems, according to the CFPB.

Writing for the CFPB blog, Student Loan Ombudsman Seth Frotman stated, “Consumers report that their servicers did this without the borrower having requested this change and, in some cases, without letting the borrower know this change was coming. While lower monthly payments could sound like a good thing, if consumers paid according to the new billing statement amounts sent by their servicers, they would make smaller payments over a longer time — potentially increasing the total cost of their loans by hundreds of dollars.”

If you discover that your loan has been redisclosed, Frotman recommends contacting your servicer and asking them to restore your previous payment schedule.

Consider refinancing

Rubin said in an interview that one of the biggest mistakes borrowers make when trying to pay off their student loans faster is sticking with their original private loans.

“If a borrower obtained private student loans to attend school, they may have a different financial situation a few years into repayment,” she said. “They may have more stability and stronger credit. A borrower does not need to ride it out with their original loans.”

If you’re in a stronger financial situation, you might qualify for a lower variable rate or a lower fixed rate. 

“If the interest on a loan is lower, then the effect of the extra payment is greater,” Rubin said.

You could also refinance your federal loans into a private loan if it would give you a lower interest rate, but you’d need to carefully weigh the pros and cons of doing so, since federal loans come with some benefits (e.g., deferment, forbearance, forgiveness) that private loans do not — as well as some ways of getting money out of you (e.g., withholding tax refunds and Social Security payments) that private loans do not. (Learn more: Refinancing student loans: What’s lost, what’s gained)

Final thoughts

Eventually, the short-term sacrifice you make by putting extra money toward your student loans will pay off and your loan balance will fall to zero. At that point, you will have just one thing left to do: request a letter from your servicer stating that you have repaid your loan in full. You might need to provide such proof to a future lender, to a credit bureau, or to a debt collector.

This letter could also come in handy if a computer glitch or human error one day makes it look as though you haven’t fully repaid your loans. With your letter and account statements, you’ll be able to prove that you no longer owe anything.

Learn more from MassMutual…

What high schoolers need to know about student loans

Biggest college freshman financial blunders

Tax refund? Don’t waste your financial windfall

This article was originally published in April 2020. It has been updated.


The information provided is not written or intended as specific tax or legal advice. MassMutual, its employees and representatives are not authorized to give tax or legal advice. You are encouraged to seek advice from your own tax or legal counsel. Opinions expressed by those interviewed are their own and do not necessarily represent the views of Massachusetts Mutual Life Insurance Company.