How to Prepay a Student Loan
Borrowers can make extra payments on the student loans they took out for college. Prepayment can reduce the interest paid over the life of the loan. Prepayments on federal and private student loans do not incur any penalties.
It is important to note that a borrower should specify that the prepayment is an extra payment – otherwise a lender could treat the prepayment as an early payment as the next regular installment on the loan. This is especially important for borrowers who have opted to have payments directly transferred from their accounts, since the lender might skip one or more of those automatic payments.
Federal regulations at 34 CFR 682.209(b)(2)(ii) for the Federal Family Education Loan (FFEL) program and 34 CFR 685.211(a)(3) for the Federal Direct Loan (DL) program require the lender to apply prepayments to the next installment if there are no instructions.
“If the prepayment amount equals or exceeds the monthly payment amount under the repayment schedule established for the loan, the lender shall apply the prepayment to future installments by advancing the next payment due date, unless the borrower requests otherwise,” according to FFEL regulations.
The regulations for the DL program are similar: “If a prepayment equals or exceeds the monthly repayment amount under the borrower's repayment plan, the Secretary — (i) Applies the prepaid amount according to paragraph (a)(1) of this section; (ii) Advances the due date of the next payment unless the borrower requests otherwise; and (iii) Notifies the borrower of any revised due date for the next payment.”
If a borrower has multiple student loans, it is important to direct prepayments to a specific loan. If no instructions are given, lenders could apply the payment to loans with the earliest due date, lowest interest rate, subsidized interest, highest or lowest loan balance or spread evenly among all the loans. Borrowers can save money in the long run by applying prepayments to the loan with the highest interest rate.
Payments are not held until the due date and are applied soon after they are received.
Tips for Making Prepayments
- Send the lender a cover letter with instructions on how to apply the extra payment
- Specify the loan by its loan ID number so there is no ambiguity
- Make sure to note the prepayment is an extra payment and not an early payment of the next installment
- It is a good idea to make the prepayment a few days after making the regular installment
When financial aid and federal student loans aren't enough to cover all college costs, consider financing the gap with private student loans. Shop around to find the loans that best fit your needs.