June 10, 2016 By College Ave Student Loans
How to Reduce the Cost of Your Student Loan
It’s no secret going to college can be expensive, and students are often faced with finding alternative ways to pay for it. As a result, it’s common for students to end up with federal or private student loans – or some combination of both.
When talking about student loans – in the news, during debates, or even when shopping for a student loan – the conversation usually centers on interest rates and the total amount of debt but very rarely focuses on the ways a borrower can reduce the total cost of student loan debt.
The reality is that at a specific point in time, like when shopping for a student loan, a borrower can’t do much to change the interest rate they are offered by the lender. But there are ways to lower student debt that a borrower can control.
Here are four tips – and a bonus one – on how to reduce the cost of your student loan.
4 Ways to Reduce the Cost of your Student Loan
In order to see the impact that each tip below has on reducing the cost of your student loan, let’s start with an example loan scenario:
Let’s assume you need a $10,000 loan for your freshman year of college.* On this loan, you get a 6% interest rate, and you elect to defer payments while in school and pay it back over 10 years.
Under this scenario, the total cost of your loan would be $16,920 (which consists of the original $10,000 loan – also called the principal – plus $6,920 in interest charges). We will use this as the baseline in all of the comparisons below, and then at the end, we will look at the impact on the total cost if you combine some of the tips.
1. Reduce student loan interest by signing up for auto-pay
Most lenders give you the option to sign up for automatic payments, and in return, you receive a student loan interest rate reduction, which is typically 0.25%. This is a very easy way to reduce the cost of your loan, and it makes your life easier as you don’t need to take the time to make a payment every month – or worry about missing one.
For example, by signing up for auto-pay as soon as you get the loan and receiving a 0.25% interest rate reduction, you reduce the total cost of your student loan to $16,581, which saves you a total of $339. Be sure to check with your lender to see if there are restrictions on the auto-pay discount.
2. Choose a shorter repayment term
When taking out your student loan, some private lenders give you the option to select how long you want to repay the loan while others assign a loan term. Having the option is a benefit for you as you can customize the loan to fit your needs. Choosing a shorter repayment term will result in a higher monthly payment, but you will save money in the long run.
For example, by choosing an 8-year repayment term instead of 10 years, you reduce the total cost of your student loan to $16,022, which saves you a total of $897.
3. Make payments while you’re in school
In the past, the standard student loan option revolved around deferred repayment, meaning you are not required to make payments while in school. After graduating (or when you are no longer enrolled) and a grace period, you would be required to start making payments. We at College Ave are setting out to change that way of thinking.
While the ability to defer payments is a great option if you do not have the ability to make any payments while in school, deferring payments significantly increases the total cost of your loan. Even though your payments are deferred, your loan is accruing interest that you’ll have to pay later. When your loan enters repayment, any unpaid interest charges are capitalized, meaning they are added to your original loan balance ($10,000 in our example). The new loan balance is the amount you are required to pay back.
Now you might be wondering – how much should I pay while in school? Making full payments while in school will result in the lowest overall cost, but many students can’t afford to do this because they’re in school and not working full-time, and that’s okay. Even if you can only make $25 payments each month, it is better than not making any payment at all.
For example, by making $25 monthly in-school payments instead of deferring repayment, you reduce the total cost of your student loan to $16,471, which saves you a total of $449.
If you’re able to afford slightly more than $25 per month, you could elect to pay just the interest charges each month, which would reduce your total cost to $16,022 and save a total of $897.
And lastly, if you’re able to afford full payments while in school, electing to pay full principal and interest with no deferral would result in a total cost of $13,322, which saves you a total of $3,597!
For more information on in-school payments, check out The Benefit of In-School Student Loan Payments.
4. Make additional payments
Lastly, if you want to reduce the total cost of your student loan and lower your payment even further, make additional principal payments while in repayment. By doing so, you reduce the principal amount owed faster than scheduled in your repayment plan thus reducing interest charges. You could make recurring additional payments every month or elect to do lump sum payments – like after receiving graduation gifts or tax refunds.
For example, if you elect to pay an additional $20 per month once you begin repayment, you reduce the total cost of your student loan to $16,191, which saves you a total of $729.
Note: Be sure to confirm that your lender does not have a prepayment penalty or fee before making additional payments.
Bonus: Refinance your student loan(s)
Another way to reduce the total cost of your student loans is to refinance them. This is especially beneficial if your credit situation has changed from the time you took out your loans. As students graduate and begin working, it’s common for them to start building a more comprehensive credit history and profile (student loan payments, rent/mortgage, car payments, credit cards, etc.), often resulting in a better credit score than when they were 18 or 19 years old.
With a better credit score, borrowers can refinance to a lower monthly payment because they qualify for lower interest rates, which will help reduce the total cost of the loans while still offering the previously mentioned benefits of auto-pay reductions and shorter loan terms. Keep in mind that federal student loans have certain benefits and options which you may lose if you refinance them into a private student loan.
Combine these tips to save the most money on your student loan
In each example, we looked at the isolated impact of each tip relative to the initial example loan scenario; however, a borrower could elect to combine these tips, which would result in significantly greater savings.
Let’s say you enrolled in auto-pay, decided to select an 8-year term instead of 10 years, and elected to make full payments while in school. The new total cost of your student loan would be $12,499, which saves you a total of $4,420 compared to the initial loan scenario!
No matter what your situation is, there are ways you can reduce the total cost of your student loan. Take advantage of some, or all, of them to help you save!
To see the impact different repayment options and terms will have on your loan, check out College Ave’s student loan calculator.
*All loan scenarios assume a $10,000 loan that is disbursed in one disbursement, four-year in-school period, and a six-month grace period.
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