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Last update: July 23, 2024
5 minutes read
Learn about the power of amortization and how understanding your student loan payments can save you time and money.
By Brian Flaherty, B.A. Economics
Edited by Rachel Lauren, B.A. in Business and Political Economy
Learn more about our editorial standards
By Brian Flaherty, B.A. Economics
Edited by Rachel Lauren, B.A. in Business and Political Economy
Learn more about our editorial standards
Ever wondered how you can efficiently manage your student loan repayments? Well, understanding the concept of loan amortization might be the way forward. By understanding these concepts, you can better plan your loan payments, and potentially save money on your student loans in the long run.
What is amortization? In simple terms, amortization is the process through which loan payments are spread out over time between the interest and principal. It involves making regular payments that gradually reduce the loan balance until it's fully paid off.
Amortization works on a predetermined schedule, starting with the initiation of the loan and ending when the entire loan is paid off. Let's take a look at an example to make it clearer:
This example shows us one aspect of amortization. You know the loan amount, the interest rate, and the term from reading the details of your student loan.
Using an amortization calculator, you can accurately calculate your monthly payment. But, how does it break down each month?
Every month, when you pay that $418, the money gets split into 2 parts: the principal and the interest. But don't assume that the split is always equal.
Let's look deeper into the first few years of an amortized loan:
Essentially, during the early stages of your loan, the bulk of your initial payments are interest. Only a small portion reduces your original borrowed amount.
Every loan is "top-heavy" in terms of interest. As supporting evidence, the first payment of $418, around $157, goes toward the principal, and approximately $261 goes toward the interest.
Yes, around 62% of your first payment ends up with the lender. And the financial load lightens up as you continue along the amortization schedule:
When I was younger and paying down loans, this felt really unfair. After all, why should so much of my payment go towards interest, rather than the principal I actually borrowed? But over time, I realized I was going to have to pay the interest at some point - so it was better to just get it out of the way early!
However, you have the power to speed up the process. Making extra payments towards your debt is one way to save on accrued interest, potentially reducing thousands of dollars and shaving years off the life of your loan.
Let's say you decided to make an additional $100 per month payment on the initial loan we discussed.
But bear in mind, going this extra mile might be a financial stretch for some people.
If you can afford it, you'll be on your way to financial freedom sooner. The key is, extra payments should always go towards your principal, not the interest.
Paying off your loan faster can save money. However, there might be other strategies.
Some finance experts argue it would be better to put your extra payment into an interest-earning account, especially if the interest rate on your loan is very low. Why?
Because after a certain point, you'd have enough to pay off the loan in one lump sum, and maybe even earn more than the interest on the loan. Deciding between these 2 paths will depend on the interest rate, your financial stability, and your risk tolerance.
Understanding the ins and outs of amortization can equip you with a powerful tool for managing and eventually eliminating your college loan debt. Let's see some crucial "do’s" and "don'ts" when it comes to your loan amortization.
Understand your amortization schedule
Make extra payments if possible
Use an amortization calculator
Regularly monitor your loan statement
Forget to specify extra payment towards the principal
Neglect your other financial obligations
Assume the same split for all payments
Underestimate the power of extra payments
Every financial strategy has its pros and cons, and loan amortization is no exception. Let's look at the potential advantages and disadvantages of this strategy:
Remember, understanding amortization can be empowering. It's all about strategically managing your money and making informed decisions.
At TuitionHero, we simplify college finance for students and parents. Our clear information on student loans and terms like amortization can help you save money. TuitionHero's services guide you through loan repayments and refinancing options. We provide the knowledge you need to take control of your debt confidently.
An amortization schedule gives you a comprehensive snapshot of how each monthly payment reduces your loan balance over time. You'll get a clear insight into how much of your money goes into interest vs principal, enabling you to strategize on making extra payments.
You can make extra payments on your loan amount either by traditional mail or online. However, it's important to specify that these extra amounts go towards principal reduction to effectively lower your loan balance.
Yes, making extra payments can help you save a big sum in interest over the loan's lifespan, and potentially reduce the loan's term as well. But, always remember to thoroughly evaluate your financial situation before deciding.
If loan repayment doesn't seem like the best option for your extra money, consider investing it into an interest-earning account. Over time, this investment might give you enough returns to pay off your loan in a lump sum.
Dealing with student loans and figuring out how they work can be a bit overwhelming, but it's okay – we're here for you at TuitionHero. Knowing more about your loans is key to making smart choices.
It's like having a friend on your side! By making good decisions and handling your loan wisely, you not only keep more money in your pocket but also set yourself up for a secure financial future. Check out TuitionHero's Student Loan Refinancing options to make your loan work even better for you.
Brian Flaherty
Brian is a graduate of the University of Virginia where he earned a B.A. in Economics. After graduation, Brian spent four years working working at a wealth management firm advising high-net-worth investors and institutions. During his time there, he passed the rigorous Series 65 exam and rose to a high-level strategy position.
Rachel Lauren
Rachel Lauren is the co-founder and COO of Debbie, a tech startup that offers an app to help people pay off their credit card debt for good through rewards and behavioral psychology. She was previously a venture capital investor at BDMI, as well as an equity research analyst at Credit Suisse.
At TuitionHero, we're not just passionate about our work - we take immense pride in it. Our dedicated team of writers diligently follows strict editorial standards, ensuring that every piece of content we publish is accurate, current, and highly valuable. We don't just strive for quality; we aim for excellence.
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