If you have ever bought a house you might know where I am going with this.
When you purchase your home you usually miss this, because you are so excited at closing you are just scribbling your name wherever they ask you to, but they show you an “Amortization Schedule.”
Myself included, we usually miss it. But basically, amortization is how the interest costs will be distributed throughout your loan, in this case usually a 30 year mortgage. In other words, it is why your $300,000 house actually costs well over $500,000 when all said and done.
But amortization doesn't just pertain to homes, it pertains to any loan, even student loans. If you have student loans, you may or may not have wondered just how your loan works and how the lender determines the schedule for how the loan gets paid off? Well read how student loan amortization works below!
Contributor note: A reader reached out to me about writing this post. Even though Brett played college football at one of my college's rival schools, his website is awesome. He runs a website called IQ Calculators which is essentially a bunch of free finance calculators. From the “Rule of 72” for investing to the amortization of your home, all these different calculators can help you determine what to do with your money.
Related Content: Debt to Income Ratio
How Does Student Loan Amortization Work?
The term for the method or schedule by which the loan balance gets paid down to zero is called loan amortization.
This is simply a fancy term for the method by which loan principal is paid, usually by equal periodic/monthly payments until the loan balance reaches zero.
When someone starts a student loan, they often receive what is called a loan amortization schedule from the lender.
The loan amortization schedule shows the schedule by which the loan will be paid off if the monthly or periodic payments are made from the first payment to the last payment.
But if you are like me, you might ask, what does all this mean?
When you look at the loan amortization schedule in more detail, it will likely show you how much of each payment is going towards principal and how much is going towards the interest with each payment on the schedule.
When a student loan is originated, almost all of the loan payment is directed towards the interest. This means that the loan balance will barely decrease in the early years of the loan.
Side note: shorter term loans will decrease greater than longer term loans in the early stages/years of the loan.
In the beginning, very little principal gets paid with the earlier loan payments. However, with each passing payment, more payment goes towards principal and less towards interest until near the end of the loan, almost all of the payment is going towards principal.
If you were to graph the principal payments on a line chart over time, it would look like an exponential curve that goes up slowly in the beginning but much faster towards the end of the loan.
So after hearing this, you may be feeling like Josh and his wife when they started paying off six figures in student loans:
That’s not fair, I can’t make any progress on my loan balance in the early years! All my money is going towards interest!
Yes this may be true, but fortunately, there is something that you can do about it. This thing that you can do is make extra periodic payments.
Make extra payments when paying off student loans (or debt).
Making extra payments each month or just extra payments when you have some spare money lying around is huge.
Unlike your monthly minimums, 100 percent of your extra loan payments will go towards principal, meaning your loan balance will decrease 1 for 1 according to the amount of the extra payment.
Sounds like a good deal right! But wait, it gets better…
If you’re following what you have read so far, you may be thinking “If I put in an extra loan payment that goes 100 percent to paying off the balance of the loan, what does that do to my student loan amortization schedule?” That is a great question and the right one!
You see, when you make an extra payment, it accelerates the loan amortization schedule so that your next loan payment will be made up of a greater amount of principal than if you hadn’t made an extra monthly payment.
To visualize how this may work in your situation, use a loan amortization calculator from IQ Calculators that recalculates the loan amortization schedule each time that you change the extra monthly payment.
Calculators like this are great for visualizing how an extra payment can really change your loan schedule.
Sample Student Loan Amortization:
Let’s take a look at an example.
For someone with a $25,000 student loan that is going to be paid off in 10 years at a 7 percent interest rate, without making an extra monthly payment, the loan is paid off in the 10th year.
During those 10 years, approximately $35,000 dollars in principal and interest will be paid. Now let’s say the borrower had $200 per month that they wanted to use to pay off their student loan early.
If they religiously put that two hundred dollars toward their loan each month, they would pay this loan off in a little over 5 years and only have paid a total of $30,000 in loan payments versus $35,000.
So in this example, they would save $5,000 and pay the student loan off 5 years early.
This is the power that making extra loan payments can have for your student loans. To sum it up, extra monthly payments help you pay less interest and pay your student loan off faster by accelerating the loan amortization schedule.
We hope that this article was informational in educating you about how loan amortization works as it relates to student loans.
And hopefully, you’ve discovered the effectiveness that extra loan payments can have in paying off student loans faster!
How student loan amortization works simply put.
Basically the more you pay now, the less you will pay later. The more you can get the principal balance down, the less interest you will pay. Remember, interest is derived off of the principal balance.
Be sure to check out IQ Calculators and see how you can plan your future finances. Personally, I really enjoy messing with these calculators just because it fires me up knowing that extra payments will help us pay off our student loans so much faster!
Q: Are you familiar with student loan amortization?
Josh writes about ways to make money, pay off debt, and improve yourself. After paying off $300,000 in student loans with his wife in less than five years, Josh started Money Life Wax and has been featured on Forbes, Business Insider, Huffington Post, and more! In addition to being a life-long entrepreneur, Josh and his wife enjoy spending time with their chocolate lab named Morgan, working out, being outside, traveling, and helping others with their finances! I got serious with money when I used Personal Capital to track my finances.