Avoid Lender Tactics that Misapply Extra Loan Payments
May 23, 2013

We always advise to pay down student loans as fast as possible and the debt avalanche program is one of the best ways to accomplish this. But there are some steps you need to take to make sure that your lender is cooperating and your accelerated repayment plan goes off without a hitch. Here are the steps you need to take to make sure that your avalanche program knocks out your debt rather than your finances.

What Is the Debt Avalanche Strategy?

We’ve talked about this before, but the debt avalanche method developed by Dave Ramsey can work with any debt, but we’ve tailored our discussions to student loans. Most people have more than one student loan and they may be at different interest rates. With this strategy, you tackle the highest interest loan first. If you have loans that are of the same interest rate – tackle the higher balance one first. The unbury.me calculator can show you how the debt avalanche method works.

What you do is pay your normal payments on all of your loans, but on that highest interest loan, you devote some of your disposable income to it. For instance, if you are paying $50 on one loan, $75 on another and $125 on your highest interest rate loan, your monthly outflow is $250. Then you take as much disposable income as you can – say $75 and send that in on your highest interest loan as well. You do this every month to fast track the payoff of that highest interest rate loan. 

Then once that loan is paid off, you would take the $125 you were paying on your highest loan plus that $75 extra you were paying in and send that in. This means that you would pay your normal $75 payment on your next highest loan plus the $200 you had been devoting to your highest loan. This will really fast track that loan for payoff. Once that loan is extinguished, you take the $200 plus the $75 and put it toward your last loan on top of the $50 normal payment. This loan will be paid off in no time at all!

So What the Cautionary Hitch?

Here’s what you have to watch out for… You have to keep an eagle eye on your lender to make sure they are applying your additional payments properly. Many debtors have complained that when they sent in extra money, instead of it going toward principal (which is the way to get your debt paid off ASAP), the lender applies it to your next payment. 

What? Yep. Using our numbers from above, the $125 would pay your monthly payment and the extra $75 would be applied to the next month’s payment. They keep applying the additional funds this way and what you’ll see on your statement is that your next due date keeps getting farther away. This is the last thing you want but exactly what your lender wants.

Why? By applying your payments as monthly payments, your loan balance is not decreasing by any substantial method because your money is going toward interest rather than principal. That’s no good for your wallet. But the lender will always do this (unless you take steps to fight it) because it’s in their best interest and maximizes how much they’ll get out of you. 

So How Do You Avoid this Happening?

You have to instruct your lender how you want the payment applied. First, you should make your standard payment as you usually do. If it’s via direct debit from your bank account, let that go through. Then call in and make your additional payment over the phone or send it in via a check and include a letter. Either method is fine, but you should instruct the lender that you have already paid your normal payment and you want the additional amount to be applied toward principal.

If you make the payment over the phone, be sure to get the agent’s name, identifying number if applicable and any confirmation code that goes along with the discussion and transaction. When you get your next monthly statement, check to ensure that you see the extra amount as a deduction of your interest.

A de minimis amount may be applied to interest (a few dollars or less) but the bulk should be applied to principal. If it isn’t, call your lender with all your documents in hand and push, push, push until it gets corrected. Even if you have to call every month and raise a little Cain about how your payments are applied, it’s worth it in the long run! And if you think you can’t afford extra money to fast track your debt, you need to embrace frugal living – these online resources can help!

If you want a concise look at your loans in one easy interface to help you get a grip on your student loan debt, please try Tuition.io’s free student loan app. You can see all of your loans (both public and private) in one simple interface, check out repayment plans and contact your lenders about payment options!

Also, please enjoy these related articles on student loan debt, payment strategies and getting yourself out of debt!

5 Drastic Tactics to Vanquish Your Student Loans for Good!

5 Must-Read Tips for Coping with Student Loans

In Financial Crisis Over Student Loans? Money Expert Offers Startling Advice

Cherry Picking Student Loan Payments – How to Save Big and Pay Down Your Loans Faster