How to Reduce Your Federal Student Loan Balance Quicker
There are lots of ways to pay off student loans.
This article was written to share a few tips I have personally used as the best way to make federal student loan payments so my money goes towards paying off student loans sooner for less money overall, while maintaining options in case of a cash flow shortage.
Paying off student loans faster and cheaper requires maintaining the mindset of always trying to minimize interest paid, but also having backup options for emergencies.
The standard repayment plan is 10 years, while the extended repayment plan is 25 years. Of course I can always pay off either one faster without penalty if I am dedicated to a repayment strategy and budget life accordingly.
I will start by saying this: I have never in my life wanted to have my federal student loan debt hanging over my head for 10 years, let alone 25 years. My plan all along has been to have my loans paid off in 5 years after I started paying on them.
So why would I choose a longer repayment plan?
I chose the 25-year repayment plan because federal student loans, even at 5-7% interest rates, are some of the most forgiving and flexible loans I will ever have for the amount of money that the government loans out.
If something were to happen and I was not able to continue making my extra payments towards my loans due to being unable to work or illness I could:
- Continue making the smaller minimum payments for the 25 year plan
- Change my repayment plan to be income based
- Put into them forbearance
Banks and private lenders are not as lenient and will take stuff away if the payments are not made on car loans or mortgages, so those loans get prioritized over federal student loans if cash flow starts to be a problem.
Picking the 25-year plan and planning to pay it off in 5 years takes strategy and discipline.
Take Aim at Interest Rates
Get a Rate Reduction with Auto-Pay
The first thing I did was see if my student loan servicer had an interest rate reduction for using their auto-pay feature, such as a 0.25% auto debit interest rate reduction incentive.
That little 0.25% may not seem like much, but for a balance of $100,000 it saves several hundred dollars a year!
Being on an extended 25-year repayment plan, the minimum required payment that is debited each month for auto-pay will be lower compared to the standard 10 year repayment plan.
This makes choosing the auto-pay feature easier because it frees up the rest of my extra loan funds to manually make a payment towards the highest interest rate loan to apply as much as possible towards the principal.
Pay Off the Loan with the Highest Interest Rate
There are repayment methods made popular by the likes of Dave Ramsey that approach repayment to have a “snowball” effect by paying off loans with the lowest balance first to give that good ol’ feeling of paying off a loan.
This feeling gives a morale boost and emotional win because now there is one less payment to make. It is supposed to be a motivator to continue this trend by paying out each loan with the smallest balance one at a time until the final loan with the largest balance is gone. This strategy works for a lot of people, however I do not use this strategy.
The problem with the “snowball” method is that it does not always save the most money because it may not be paying the highest interest rate loans off first, and in the financial world, interest rates are the key to minimizing paying interest to maximize personal wealth.
The math does not lie.
Taking the same payment amount that would apply to the smallest loan balance via the snowball method and instead prioritized paying towards the highest interest rate loan first while paying the minimum on the rest of the loans would save money compared to the snowball method every time if repeated in this manner until the loans were paid off. This is sometimes called the “avalanche” method.
The larger the spread in interest rates, the more money saved by paying the highest interest rate loan off first. I will always pick savings over a short term “Victory!” from having 1 less payment.
Remember what I said about mindset?
It confuses me why one would choose to ignore the money saving aspect of paying off the highest interest rate first (avalanche) in favor of having 1 less account to pay towards (snowball).
If I was told that I could either make 3 separate payments a month for my phone, internet, and cable at $30 a piece (that’s $90 a month) OR make 1 payment a month of $100 for all three together – which would I choose?
For me, the 1 less payment is not as nice as the money that is saved.
Having said that, it has been said that the best exercise plans are the ones that are actually done.
The same could be said for financial planning. A good plan that is followed is a better than the best plan that is not consistently adhered to and followed through on.
If someone doesn’t feel like they can stick out prioritizing paying on the highest interest rate loans first to pay less money in the long run, then they can continue snowballing their way to being debt free. They just need to understand that they will be paying more money in the end compared to paying off the highest interest rates first.
Sometimes I do get emotional about finances. I think of how happy I will be with the extra money I saved after I pay off my loans cheaper and faster by paying off the highest interest rate loans first.
Confirm Extra Payments are Being Applied the Right Way
Extra Payments: Are They Decreasing Principal or Advancing Due Date? Or Both?
When making a payment that is more than the minimum with the intent to reduce principal balance and pay off the loan quicker, it should be confirmed that extra payments are not being held and accruing interest until the next due date. Below is a snippet of a customer service chat I had with my loan servicer after I noticed my due dates were being advanced when I was prepaying on loans.
Me: “I would like confirmation that my payments over the minimum are being applied to my principal balance immediately NOT being held and accruing interest while waiting for the next advanced due date.”
Nelnet Representative: “Your payments were applied the day they were effective for. But since you paid more than the minimum amount, you are now considered paid ahead. We don’t hold onto payments until they are due. It has already been deducted from your balance.”
I still track the payments and balances each month, but contacting them was easy enough and provides some peace of mind that my servicer isn’t ripping me off like some servicers have in the past.
Nelnet has a description of how payments are allocated here. You can see how they describe the situation for paying more than the current amount due below.
“Unless you direct your payment to an individual loan or loan group, the default allocation method is followed. After your current amount due is paid, your payment will be allocated across loan groups in proportion to each loan group’s regular monthly payment amount, or in the case of no payment due (if your loans are not in repayment), in proportion to each loan group’s accrued interest.
You have the option to direct your payments (including partial payments) to individual loans or loan groups, as a one-time or recurring special payment instruction. See special payment instructions for more information.”
Nelnet has their special payment instructions here and read as follows
“You should provide special payment instructions when:
- You are making a payment greater than the current amount due and do not want to advance your due date more than one month.
- You are making a payment (including partial payments) and would like to direct it to individual loans or loan groups.
- Note: You have the option to provide one-time or recurring special payment instructions.”
Nelnet also states you can request that Nelnet processes your payment using your special instructions by phone, email, or mail
“direct your payments (including partial payments) to an individual loan or loan group, or request us to not advance your due date more than one month, as a one-time or recurring special payment instruction by contacting us”
If you don’t have Nelnet and your servicer does not provide similar instructions for these situations it is probably worth contacting the servicer to see what process they follow and direct them with how you’d like your payments to be applied.
Everybody has a different financial situation that requires researching and planning out individually to fit personal needs.
Having a disciplined and rationale repayment strategy that still allows flexibility in case of other expenses has given me a goal to work towards being free of my student debt.
Run the numbers, make your plan and stick to it.
For help keeping track of your student loans, check out our free student loan spreadsheet to keep your loans organized.