The Student Loan Ranger receives many questions from readers. On occasion, we like to share some queries that other borrowers are likely to relate to.
Here’s a sample of one we’ve addressed recently. The question has been edited for clarity and to protect the reader’s privacy.
Q: I graduated graduate school with combined loans of $120,000. The $120,000 is split among six different loans. I‘m currently on a federal income-based repayment plan. I plan on tackling the loans using the avalanche method, but is there a better way for me to approach them?
I’m considering the following two options:
- Pay minimum and extra payments toward highest interest and just pay the minimum on all other loans (accruing monthly interest on the five other loans).
- Pay minimum and extra payments toward highest interest and just pay the minimum and a little extra on all other loans (accruing no monthly interest on the five other loans).
Does whatever outstanding interest remaining at the end of the year turn over and become a part of the principal balance at the beginning of the next year?
It is great that you are taking such careful consideration of how to repay your student loans. Based on your questions, it sounds like you’ve already done some research on the best debt repayment methods. There are two popular methods of debt repayment: the snowball method and the avalanche method you mentioned.
[Read: 6 Tips to Make Extra Student Loan Interest Payments Correctly.]
The avalanche method is when debt is put in order from highest interest rate to lowest interest rate regardless of the balance. Payments are then made in that order, first to the loan with the highest interest rate until it is paid off, then to the next highest and so on. This is the most efficient way to pay off the debt so that the least amount of interest is accrued.
The snowball method is when debt is ordered from lowest balance to highest balance. Then payments are made to pay off the lowest balance debt first and so on regardless of the interest rates of those balances.
As a debt is paid off, the amount that was being applied to that debt is then added on to the payment being made to the next highest, creating a bigger “snowball” to get rid of the debt. Some people choose this method because benchmarks are easier to reach and can provide motivation to keep going.
Here are some factors for borrowers like you to keep in mind when trying to determine how to pay off multiple student loans.
Choosing the right repayment strategy can save thousands in interest. The interest on your loans is going to accrue regardless of whether you pay the minimum or the minimum plus a little more. With the avalanche method, paying the most on the loan with the highest interest rate will give you the biggest bang for your buck.
Since interest will continue to accrue on the highest rate loan quicker than the other five loans, the Student Loan Ranger recommends putting all the extra funds to that loan first.
Interest capitalizes at specific times in the life of student loans. Capitalized interest is interest that gets added to the principal balance after periods when payments have not been made, such as during the grace period, deferment or forbearance. To answer your question, interest does not capitalize at the end of each year.
[Read: What to Know About Federal Student Loan Repayment Options.]
If a borrower chooses not to pay the interest while in school or during the grace period, deferment or forbearance periods, interest will accrue and be capitalized.
According to Federal Student Aid, an office of the U.S. Department of Education, if you have not been paying the interest during the grace period or while in school, the amount that accrued while in school has most likely already been added to the principal. In addition to this time, there are other instances that interest is capitalized.
Unpaid interest will generally capitalize on student loans if the borrower voluntarily leaves the Revised Pay as You Earn, Pay as You Earn or Income-Based Repayment plans; if the borrower fails to annually update his or her income for some of the income-driven plans; or if the borrower no longer qualifies to make payments based on income.
[Read: How Student Loan Repayment Plans Affect Delinquency.]
Be sure to contact your loan servicers to discuss how you would like your extra payments applied to your loans.
Set small goals to keep from feeling burned out. It may take some time to feel the satisfaction of a zeroed-out balance going from highest interest rate to lowest with the avalanche method. But with endurance, you will ultimately save the most money and pay off the student loans more quickly using this method.
If you feel burned out from paying off debt, the Student Loan Ranger recommends enlisting some trusted friends for accountability and to help you celebrate small victories. Set small goals.
For example, set a goal of paying off $5,000, or whatever amount seems logical based on your budget, and have a set reward for yourself, like a special dinner, a day trip or an indulgent purchase as a reward. Just be wise with how much you spend so it doesn’t thwart your debt goals. Having small treats for each milestone can help you stay motivated.