6 things to know about amortization of student loans | Ranger student loan
Developing a financial plan to pay off your student loans can be overwhelming, but it doesn’t have to be. Amortization is one of the many technical terms that can seem like a daunting concept, but understanding it is essential to finding the right repayment plan and paying off your student loan faster.
Here are six things you need to know to understand student loan amortization:
- The vast majority of student loans are installment loans.
- All student loans are amortized.
- Depreciation changes over time.
- An amortization schedule can show you how your payments are applied.
- Your repayment plan affects your amortization schedule.
- Negative amortization can increase your loan balance.
The vast majority of student loans are installment loans
There are generally two types of loans, renewable and installment.
Revolving loans, like your credit card, provide a line of credit that you can borrow on on an ongoing basis. Installment loans are borrowed as a lump sum and repaid over time according to a payment schedule. All federal student loans and most private student loans are installment loans.
You might have borrowed at the start of each school year to pay for tuition and other education-related expenses, but that probably just means that every year you take out a new student loan. Unless you consolidate or refinance, each of your student loans is a separate installment loan.
All student loans are amortized
All installment loans, including student loans, are amortized. Amortization is the process of paying off an installment loan through regular installments.
When a student loan is amortized, it means that part of the monthly payment is applied to interest and part is applied to reduce the principal balance.
Depreciation changes over time
Although you will be paying the same amount each month on your student loan, the portion of your payment that is allocated to interest changes over the life of the loan.
In the beginning, most of your payment goes towards interest. Even if you make regular payments every month, the loan principal balance decreases more slowly during this period.
Don’t worry, though! As your principal balance decreases, less interest accumulates each month, so more of your monthly payment is applied to principal, reducing your student loan balance faster.
If you can pay more than your fixed monthly payment, you can pay off your student loan faster and reduce your total payments by asking that any additional amount be applied to principal. Just be sure to talk to your student loan officer about how to apply the payments. Your server is the organization that sends you invoices and collects your payments.
An amortization schedule can show you how your payments are applied
An amortization schedule is a schedule that shows the amount of principal and interest you pay each month during the term of a loan. Although each payment you make is the same amount, remember that the amount of interest paid by each payment decreases over time.
To better understand how it works and to see how your payments are applied, ask your loan manager for an amortization schedule.
Your repayment plan affects your amortization schedule
If you have federal student loans, you can choose from several different repayment plans that affect how quickly you will pay off each loan. Standard repayment – in which payments are fixed and made for up to 10 years – is the fastest way to pay off your loan because you’ll be paying more each month over a shorter period.
However, if you have difficulty managing the monthly payments under the standard repayment plan, you may consider signing up for a graduated repayment plan, which starts with lower monthly payments that increase every two years, or requesting an income-based repayment plan, which sets monthly payments based on your income and the size of your family.
These changes will affect your amortization schedule, and you should talk to your loan manager to better understand the impact.
Negative Amortization Can Increase Your Student Loan Balance
Be careful! If your monthly payments are less than the amount of accrued interest, the unpaid interest can be capitalized and become part of the principal. This is called negative damping.
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Negative amortization can increase the total amount you owe on your student loan over time, even while you are making monthly payments. If possible, always try to pay the full amount of interest you owe each month, and asking your service agent for an amortization schedule can help you do that.
As your circumstances change, you may want to consider switching to a repayment plan with a higher monthly payment so that the payments will decrease your principal balance more quickly over time. Your repairman can help you understand these options.
By understanding how amortization works, you can make better financial decisions as you work to reduce and eventually pay off your student loan debt.