We always recommend paying off your student loans as quickly as possible. Not only does this get you out from under the onus of educational debt sooner, but it can save you money and allow you to move on with your life and focus on your debt-free future. But a recent statement issued by the Consumer Financial Protection Bureau (CFPB) indicates that if you are trying to get out of student loan debt faster, your loan servicer may be roadblocking you either intentionally or because of a lack of flexibility in their processing systems.
What consumers are complaining about is that if they send in money on top of their standard student loan payment, it’s not properly applied. The best approach for you, the borrower, is to have your additional money applied to the principal on your highest interest loan. The best approach for the lender/loan servicer is to apply the additional money to future payments rather than principal. Their next best option is to apply it to the principal of your lowest interest rate loan.
Why loan servicers don’t want your money sooner
If you loaned your BF $300, it seems like you’d want it back next month rather than next year, right? That’s because you’re likely not charging them interest. For-profit lenders make money in a few different ways. First is by charging the highest interest rates possible. Second is by the length the loan is outstanding – the longer, the better. Third is by charging late fees (and other fees) as often as they can and as much as they can. Simply put – the faster you pay off your loans, the less your lender makes.
Why loan servicers don’t want you to have discretion on applying payments
Absent any instructions from you, or a policy that pledges to process your payment in the manner that best benefits their customer, lenders will typically consider any overpayment as a “prepayment” on future loan installments. For example, if you have three loans from a particular lender and your monthly installment payments total $240, you may send in $240 plus another $100. They will apply the $240 normally, and then will apply the other $100 to any unpaid interest that may be lurking from a prior underpayment, and then will apply any remainder to payments for next month. This will save you a little bit of interest in the long run, but not near as much as if they applied it to principal – and they know this… But it allows them to maximize profits by minimizing the impact of your extra money remitted.
How you can fight back against misapplication of loan payments
The best strategy to stay on track with your student loans is to enroll in auto-debit for your monthly installments. Many lenders will also give you a small interest rate break (around .25%) for signing up for automated payments. Then, when you have extra moolah to put towards your debt, send it in via check (yes, that old-school piece of paper that few utilize anymore) along with a note specifying how you want it applied. Why a check? Automated payment conduits often do not have a place for you to include instructions, or those instructions are ignored or not sent along with the transfer of funds to your lender/servicer.
Send your additional money in immediately after your monthly auto-debit comes out of your account. Why? Right after your scheduled payment, there should be no accrued interest lurking around to eat into your overpayment. This will give you the most bang for your buck.
Specify in the note that you want it applied to the principal of your highest interest loan. But don’t tell them exactly that verbatim – instead, provide them with the loan number of the highest interest loan and tell them, “Please apply this payment to the principal of loan number 1234.” If you don’t specify the loan by its account number, they can plead ignorance if they apply it elsewhere.
Finally – and this step can seem a senseless hassle – you need to confirm that the payment was posted as requested. You’ll need to do this each and every time you make an overpayment. If you don’t follow up on it, you will have a hard time requesting corrections long after the fact. If you notice the payment was misapplied soon after it was made, you should contact the lender/servicer and request that it be properly applied and an interest correction be made to reflect excess interest charged because of their misapplication.
A great way to track your payments and ensure they are being posted properly is by signing up for Tuition.io’s free student loan tool. You can track your debt, see payments, check out payoff dates, see the impact of changing your repayment plan and the effect of making those additional payments. And also be sure to read our blog daily for news and info on student loan matters.