Your Interest Only Payments Will Equal:
What Are Interest Only Student Loan Payments?
Under a standard repayment plan, student loan payments are allocated to both principal and interest. This way, the borrower is able to pay off all accumulated interest, but can also make a dent in the balance, allowing him or her to repay the loan in full over time. On the other hand, interest-only payments, as the name suggests, cover only the interest that accrues on the loan each month.
The Pros and Cons Of Making Interest Only Payments On Your Student Loans
Some borrowers opt to make interest-only payments on their student loans during in-school deferments. While there are certainly benefits to this strategy, there are a few drawbacks as well.
If you’re considering interest-only payments, here are the pros and cons:
Reducing interest expenses: One of the most often-cited reasons for making interest-only payments is to reduce the amount of interest paid over time. By paying off the interest that accumulates each month, you’ll prevent it from being capitalized. When interest is capitalized, it is added to the principal balance, and interest for future periods is calculated using the new total. (With federal student loans, interest is capitalized when a borrower graduates or drops below half-time enrollment. Private lenders may capitalize interest on a monthly basis, even during an in-school deferment.)
Building good habits: By making interest-only payments, you’ll get into the habit of making your monthly student loan payment. According to experts, borrowers who make on-time payments for the first 12 to 15 months are much less likely to default over the life of the loan.
Borrowing too much: Critics of this strategy argue that those who can afford to make interest-only payments are borrowing too much. They say that these borrowers should put the funds they plan to use to make interest-only payments toward education-related expenses and take out less in student loans.
Diverting funds that you may need: By making monthly payments, you may forgo the opportunity to build up a solid emergency fund that will provide some peace of mind while you complete your degree. As an alternative, some experts advocate making monthly contributions to an interest-earning account. The idea here is to wait until graduation to withdraw the funds and pay down accumulated student loan interest. With most federal student loans, interest isn’t capitalized until the end of a grace period, which starts right after graduation. So, technically, there’s no difference between making interest-only payments each month and making a lump-sum payment just prior to the end of the grace period.
How Much Can You Save by Making Interest-Only Student Loan Payments?
Over the long run, you can save money by adopting an interest-only repayment strategy. To see how this might work, let’s look at an example scenario.
Let’s say that our borrower, a graduate student, has a $60,000 loan balance, with a 5.31% interest rate, and decides to make interest-only payments during a two year in-school deferment. Each month, the loan balance will accrue $265.50 in interest and over the 24 month period our borrower will pay a total of $6,372 to cover interest expenses. Upon graduation, she will owe $645.52 each month under the Standard Plan, which spreads out student loan payments over 10 years. In total, she will pay $83,834.40 over the life of the loan.
If she opted to forgo those interest-only payments, she would pay $85,689.60 over the life of the loan, an increase of $1,855.20.
Of course, how much you can save will depend on how much you borrow and the accompanying interest rate, among other factors.