You’re not aloan.
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(this is a repost/update of a note I wrote in 2011) This is my experience with Sallie Mae, and I have been told it applies to many other private lending companies.
Earlier this year I took some of the money I had saved over last summer and applied it my student loan debt because of the advice of my uncle. He explained to naive me the true meaning of compounding interest and how essentially I was hurting myself by keeping the money in savings rather than paying down my debt. His reason was simple: in my savings account, the $5,000 was accruing roughly 1–2% in interest annually. That same $5,000 could be put towards my student loan which has a 9.25% interest rate (horrid, I know) and was actually costing me in 2 months what I would receive in interest from my savings account in a YEAR. Worse, would be spending that $5,000 frivolously, but we’ll get to that later.
Breaking that down-
Two month’s interest at 9.25% on $5,000 = -$77.08
One year’s interest at 1.5% on $5,000 = +$75
So, I would lose (without even taking into account that interest compounds) $387.48 annually by keeping money in savings versus paying off the loan.
I hope you’re still with me, because I haven’t even gotten into it yet.
My loans with Sallie Mae as of Jan 2011:
(LOAN A) $17,000 interest rate of 9.25% — 87.1% of the total loan
(LOAN B) $2,500 interest rate of 6.55% -12.9% of the total loan
On January 20, I made a payment of $4,200 on my loan (after paying the monthly minimum the week before on both loans). What was never offered to me was an option on which to pay it towards, but I made the mistake of not looking into it further.
In the months that followed I have made additional payments (larger than the minimums) intending to pay off the principal of the larger loan with the MUCH higher interest rate, until yesterday I discovered how Sallie Mae (and many other loan companies) will actually apply payments.
The payment on Jan 20 of $4,200 was applied (without any option for me to change it available) as so:
$3,311.26 (79.7%) to Loan A (larger loan/higher interest rate)
$842.31 (20.3%) to Loan B (smaller loan/lower interest rate)
Without looking any further…this may seem normal to anyone. It seems fairly balanced, however, this is exactly how loan companies make money- screwing over the unsuspecting borrower.
Let’s break this down- my minimums for the month were paid, so I owed no money towards the smaller loan and very little to accrued interest that week. The smaller loan is on a 59 month payment plan, but since it has a smaller interest rate than the larger loan, actually, 2.7% smaller, I would be a fool to pay it down before paying the larger. Why? Well, this is exactly the reason everyone needs to pay attention.
$842 is the amount we are talking about here that was paid to loan B. For simplicity, let’s say $800 should’ve been applied to Loan A, but Sallie Mae decided to apply it to loan B. No big deal right? Wrong.
Loan A is on a 137 month payment plan. In years, that’s about 11.5 years. So, after I’ve long paid off Loan B (which would be much faster than their plan with the way they have applied my payment), I would actually still be paying compounding interest on that $800 that wasn’t applied to Loan A.
Reduce it down to the 2.7% difference in annual interest rate.
My friends, here is the beauty of compounding interest:
Years | Amount Owed on -$800
1 $821.60
2 $843.78
3 $866.57
4 $889.96
5 $913.99
6 $938.67
7 $964.01
8 $990.04
9 $1,016.77
10 $1,044.23
11 $1,072.4
11.5 $1,088.51
Total amount lost to compounding interest on a single $800 payment: $288.51
Well, you may think that’s not much…but remember, this was one loan payment I made. Yes, it was a big one, but it gets worse. The payments (above interest and minimum payments) the following 3 months were applied 70% to Loan A, 30% to loan B…instead of 100% to the larger loan. This means 30% of all of my payments are accruing/compounding 2.7% interest over time that they didn’t have to be.
I’m not going to even break it down. 2.7% of anything, compounding, let alone how much it would end up being on a $15,000 loan being repaid over eleven years. In just the four payments that I’ve made since January, the additional amount I would pay Sallie Mae is $700. That $700 is money Sallie Mae would’ve pocketed had I not noticed and spent 2 hours being rerouted between several service agents till finally reaching someone at headquarters with the authority to change my 4 payments back to the way I intended to pay them.
The agent also split my loans into two separate billing groups so I can pay minimum on Loan B and pay whatever I please on Loan A above the minimum. There is also roughly $3,000 in payments I made in 2008 that were also split 70/30 without me knowing, so for 3 years several hundred dollars has been accruing 2.7% in interest- all profit to Sallie Mae. As if 9.25% & 6.55% were not enough in the first place.
Sallie Mae’s rep said their method of splitting payments to principal balances is based on whatever they feel like doing (ie “we’re screwing you and we know it”).
I also have two Federal loans with different interest rates, they split payments above the minimum proportionally to the loan amounts. While I would prefer the method I’ve described with Sallie Mae, at least Great Lakes method of splitting the payment is logical.
For context, I’ll give one more varied example. I have a friend who has 6 loans through one company totaling around $60k. The interest rates vary from 4-8% (6.2% average of the unsubsidized), with two of the loans being subsidized, but the rest are not. Deferring payments is an option, but one very important thing to note is deferring does not mean the interest accrual will stop unless the loan is subsidized. So, this means each month, even while payments are deferred the $50k in unsubsidized loans is accruing interest, and then interest on the interest, and then INTEREST ON THE INTEREST ON THE OMGGGGGGGG.
This looks like:
In the small print…look at those numbers. $110,244! $87,362! Depending on your payment plan, you will likely be paying at least 50% more than the initial loan, and potentially more than DOUBLE.
If you want to save your self hundreds, likely thousands of dollars, LEARN about what your loans actually cost you. Consider what buying a $500 iPad when you have $30,000 in loans actually means in the long term. (On a loan with 7% interest, your $500 iPad will cost you over $1,000 in compounding interest payments after 11 years of paying your loans at minimums).
Should you refinance? That depends on your situation, and honestly, your credit. If you can put all the loans into one place with a lower average interest rate, I can’t imagine why you wouldn’t do it. There are many tools out there for refinancing — You can use my referral code for both SoFi and Lendable and both offer a bonus for signing up.
If you have any questions about your loans, shoot me a message…I will do my best to help you or refer you to someone who can. In most cases, it’s just plugging some numbers into excel, so send em over!
