Borrower question: “How do I pay toward the principal of my student loan?”
One of the most common questions student loan borrowers have is: “How do I pay toward the principal of my student loan?” That’s because your ultimate goal is to pay your loans in full. In fact, you might even be actively working to pay them off faster than required — a great strategy to save money in the long run.
Your loan is considered paid in full once you’ve paid the original amount you borrowed plus any fees and the interest that accrued during the time you borrowed the money. The good news is, each time you make your regular on-time monthly payment, your principal balance decreases, making you one step closer to finishing this chapter of your financial life. (Further down, we discuss income-driven repayment plans which could lower your monthly payment but may not cover the amount of interest that accrues each month.)
How payments are applied to your student loan
If you want to know how to pay down the principal of your loan, it’s first important to understand how your payments are applied to your account. Generally speaking, the three components of a loan are fees (if any), accrued unpaid interest, and principal (read this article to learn more). When you make your monthly payment, typically the payment is applied in that order. Assuming you don’t have any late fees or other fees (most loans don’t), any amount paid over the accrued unpaid interest reduces the principal.
The interest paid from your monthly payment is the amount that accrued since the last time you made a payment. Or, if your last payment did not cover the interest accrued, your current payment will cover that interest too.
Paying off sooner by paying extra
Another way to look at interest is to think of it as a time continuum. Your loans accrue interest during the time it takes to pay them off. It’s important to know interest accrues daily based on your outstanding loan balance. The lower your balance, the less interest will accrue.
To find out how much interest accrues daily, use this formula: (Unpaid Principal x Interest Rate) ÷ 365 (number of days in the year) = Approximate Daily Interest.
If you pay more than your minimum due — known as an “overpayment” or an “extra payment” — the extra amount will reduce your balance even further. As a result, you’ll end up shortening the amount of time it takes to pay off your loan which means you will pay less interest over the life of the loan.
For example, if you make an extra payment a week after you made your regular monthly payment, then a week’s worth of interest will have built up during that time.
That means the extra payment will first be applied to the week’s worth of accrued interest, and then any remaining amount is applied directly to your principal.
If you pay extra at the same time you make your regular payment, then the entire extra amount will be directly applied to the principal because all accrued interest was satisfied by your regular payment.
Let’s try another example using real numbers. Say your current loan balance is $25,000.00 with a 6.8 percent interest rate and a payment due on the first of the month. At this balance and interest rate, $4.66 in interest accrues each day — or $144.46 in total this month. Your regular monthly payment amount is $287.70, so the first $144.46 will cover the interest that’s accrued. The remaining $143.24 goes to principal. And — voila! — your new principal balance is $24,856.76. Now $4.63 in interest accrues each day because each time you lower your principal balance your daily interest accruing declines too.
Next, let’s say on the 15th of that same month you make an extra payment of $100.00. During the 14 days since your last payment, $64.82 of interest has accrued, so the first part of your payment covers interest. The remaining $35.18 is applied to principal, further reducing your principal balance. You’ll find the same principle at work in other forms of consumer credit like an auto loan or mortgage.
When you make your next regular monthly payment on the first of the next month, only $78.54 of interest will have accrued since your last payment. That means the remaining $209.16 of your payment will be applied to principal. Check out the chart below: as your principal balance declines further, the daily interest keeps getting lower, too. Keep it up and your loan gets closer and closer to being paid off!
What happens when you make an extra payment
By definition, an extra payment is any amount which exceeds your regular monthly payment amount. You can pay as little or as much extra as you want — including making a full month’s payment extra (known as a double payment) or more! The choice is yours. No matter how much extra you decide to pay, your payment is applied to interest and principal the same way.
Once you pay extra, your loan statement may show that no payment is due, or that your amount due next month is reduced by the amount you paid extra. Sometimes this is referred to as advancing the due date or being “paid ahead.” Being paid ahead does not mean your servicer is waiting to apply your extra payment to your account.
If your billing statement reflects either a smaller amount or $0 due next month because of your extra payment, but your goal is to pay off your loans sooner, then keep making your next month’s payment as usual.
As the chart above shows, continuing to make extra payments will reduce your total costs of borrowing.
How income-driven plans can affect your balance
Income-driven repayment plans, available for federal student loans, let you lower your monthly payment amount and can be a good option if you have high federal student loan debt relative to your current income. These plans have names like Pay As You Earn or Income-Based Repayment. If you’re enrolled in one of these plans, be aware that your monthly payment amount may actually be lower than the interest that accrues each month.
When you sign up for an income-driven repayment plans, be sure to understand whether your balance may grow. If you see your balance growing rather than declining — and you can afford to pay more — consider doing so by making extra payments or switching to a different payment plan.
Let’s sum it all up
Let’s take a moment to recap a few key points about paying down your principal:
- Payments are applied to late fees (if any) and interest accrued since your last payment, and then the remainder goes to principal — just like other consumer loans.
- Any amount paid beyond the interest due is always applied to the principal of your loan — you don’t need to request it be applied to your principal.
- Even if your account status shows you are paid ahead or have a lower amount due, keep making your regular payments as usual to reap the benefits of paying extra.
- If you want to pay off your student loans faster, pay extra whenever you can afford to — and keep it up.
Brianna Huff is the communications specialist for Navient, a leader in education loan management and business processing solutions.