Back in September I wrote about how structuring your borrowing and investing decisions properly in the first place is superior to continually trying to optimize and re-optimize them. However, there’s an important corner case where you’re able to optimize your post-borrowing behavior, and that’s the case of student loans.
Depending on a number of factors including the prevailing student loan interest rates when you were enrolled, the number of years you took to graduate (or drop out — we don’t judge around here), and the student loan repayment regime when you were enrolled, you might have a number of federal and private student loans with different interest rates and different repayment options.
For loans which are eligible, I’m the world’s biggest proponent of “income-based repayment,” or IBR. Your payments are capped at a percentage of your income, and any remaining balances are forgiven at the end of the IBR repayment period.
However, folks who know they won’t be eligible for IBR loan forgiveness (or the public service loan forgiveness program) may understandably want to accelerate the repayment of their student loans. That impulse may become even more tempting if the Republican Party succeeds in their effort to repeal the federal income tax deduction for student loan interest, which would almost double the after-tax cost of student loan interest for high-income borrowers.
Send your student loan processor written instructions on how to process payments in excess of the minimum
Thanks to the consolidation of the federal student loan program under President Obama, there are relatively few student loan servicers today, but each has somewhat different methods of processing payments in excess of your monthly minimum owed.
If you don’t know how your student loan servicer processes excess payments, you may be shocked (or disgusted) to learn that they are not required to apply payments in excess of your monthly minimum to your highest-interest balances. They are, legally, free to apply excess payments to your loan balances in any manner they choose — unless you instruct them otherwise.
So, instruct them otherwise! The Consumer Financial Protection Bureau has produced a draft letter you can use to specify exactly how excess payments should be applied to your student loans. Read it carefully, fill it out with your own personal information and preferences, and send it by certified mail to your loan servicer. Then check with them in 10-14 days to make sure they’ve received and applied your instructions to your account.