How student loan amortization works
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Amortization simply refers to the process of paying back your student loan through regular monthly payments over a set period. Federal student loans in standard repayment, for instance, are amortized over 10 years, with a certain amount of each payment going toward interest charges and the rest going toward your principal balance. The same goes for private student loans on a specific repayment term.
It’s important to understand how negative amortization can affect your student loans, however, and what you can do to avoid it.
What is student loan amortization?
Amortization refers to the process of paying back an installment loan, such as student debt, with fixed payments over a set period. Many student loans are amortized over 10 years and require fixed monthly payments.
Depending on your loan, though, you might have a longer or shorter repayment period. As you pay back your debt, a part of each payment goes toward paying down interest charges, and the rest goes toward reducing your principal balance.
“In a typical amortization schedule, a borrower’s monthly payment covers all of the accruing interest each month along with some principal, so that the overall balance gradually goes down over time until the loan has been paid in full by the end of the repayment period,” said Adam Minsky, a student loan lawyer.
Amortization in action
Your loan’s amortization schedule shows how your payments are applied to your student debt each month. However, the ratio of your payment that goes toward interest costs vs. the loan’s balance changes over time.
At the start of your loan term, a large portion of your monthly payment goes toward interest. As your loan term winds down, more and more of your payment goes toward your principal balance until the final payment brings your balance down to $0.
Let’s say, for example, that you owe a $10,000 loan at a 5.00% interest rate. The repayment term is 10 years and you make monthly payments of $106. Here’s your amortization schedule for the first three months of payments:
| Month | Payment amount | Interest paid | Principal paid | Remaining balance |
|---|---|---|---|---|
| 1 | $106.07 | $41.67 | $64.40 | $9,935.60 |
| 2 | $106.07 | $41.40 | $64.67 | $9,870.93 |
| 3 | $106.07 | $41.13 | $64.94 | $9,806.00 |
And here’s your amortization schedule for the final three months of payment:
| Month | Payment amount | Interest paid | Principal paid | Remaining balance |
|---|---|---|---|---|
| 118 | $106.07 | $1.31 | $104.75 | $210.81 |
| 119 | $106.07 | $0.88 | $105.19 | $105.63 |
| 120 | $106.07 | $0.44 | $105.19 | $0 |
How amortization affects your student loans
Amortization reveals the month-by-month process of paying your student loans back. While your monthly payments may never change, amortization can affect your debt in some significant ways.
Your payments are applied differently over time
At the start of repayment, a larger portion of your student loan payments goes toward interest. As the years go by, more and more of your payment will go toward your principal balance.
Near the end of your amortization schedule, nearly all of your monthly payment will pay down your principal loan and only a small amount will go toward interest charges.
Your repayment plan can change your amortization schedule
If you adjust your repayment terms, your student loan’s amortization will change as well. Adding years to repayment via switching repayment plans or by refinancing, for instance, typically reduces your monthly payments and leads to increased interest costs.
Making extra payments, on the other hand, can accelerate loan repayment and save you money on interest.
Negative amortization is possible
If your monthly payments aren’t large enough to cover your full interest costs, your loan balance could grow, rather than decrease, over time. In this case, a lender may add the leftover interest charges to your principal balance in what’s known as interest capitalization.
Even though you’re making payments, your loan balance could just keep getting bigger due to interest. Negative amortization can occur when your loans are on an income-driven repayment plan (because your minimum monthly payment is lowered) or in deferment or forbearance (your minimum monthly dues are paused).
How to take advantage of amortization
Reviewing your student loan’s amortization schedule can help you determine whether your repayment term works for you. See if your lender provides one by logging into your online account or reviewing your loan’s paperwork. If it’s not readily available, contact your lender or loan servicer, or estimate your schedule using an online amortization calculator.
As you review your schedule, consider the following:
- Make sure your loan isn’t in negative amortization. Your monthly payments should cover more than the interest and your balance should be decreasing over time.
One exception to this rule is if you’re working toward loan forgiveness. If you’re pursuing Public Service Loan Forgiveness (PSLF), for instance, the government will forgive your federal loan balance after 120 on-time payments on an income-driven repayment plan — so negative amortization wouldn’t affect you.
- Consider paying off your student loan faster. If you have the cashflow to do it, making extra payments can accelerate repayment and save you money on interest. Just make sure your loan servicer applies the extra payments to your principal balance.
- Explore refinancing your student loans for better rates. Reducing your interest rate through student loan refinancing can save you money on your loans and help you pay them off faster. You’ll also get the option to pick new terms with a revised student loan amortization schedule.
Keep in mind, however, that refinancing federal loans means forfeiting access to federal programs, which wouldn’t be the right move if you’re pursuing PSLF or utilizing an income-driven repayment plan.
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