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Paying Down Loans: Mastering Amortization & Principal Payments

Loans

One of the most common financial experiences you will have in your life is taking out a loan of some form. Whether it’s a student loan, an auto loan, a mortgage loan, or anything in between taking out a loan is bound to happen to the average Joe. What I think needs to be discussed is what happens after the loan is taken out.


With all that in mind… let’s talk about paying down a loan.


Amortization Schedules

Every term loan on the face of the Earth (or at least in the U.S. to be less dramatic) has an amortization schedule. That’s just a fancy term for a graph of how much interest and principal you will be paying through the life of your loan.


When you receive a loan the banks know on day one how much interest they are going to charge you for the entirety of your loan. All of your interest is calculated ahead of time, and the established monthly payment amount ensures you pay the entirety of the principal and interest they want.


It’s important to understand that the bank is assuming you are going to pay by the agreed schedule and on the designated payment dates. If you pay outside of these terms, you will be on an adjusted amortization schedule. This means you don’t have to pay all that interest; in fact you can save hundreds of dollars and shed months off the term of your loan. I have details on how to later in this post.


As a borrower you have a legal right to this information. You can request to see an amortization schedule from your lender at any point in time during the life of your loan. I do not know if all banks adjust the schedule based on your current balance, or if they just have standard schedules based on the original terms. Either way, you can request this information. Some banks are really cool and provide the schedule with the signing documents when you are opening the loan!


If you are thinking about borrowing and want to know how much interest a loan would cost you, you can use online calculators. There are plenty of online amortization schedule calculators. If you Google it I’m sure you’ll get a ton of results. I use this one because it has a graph and I like visuals: https://www.calculator.net/amortization-calculator.html


How do I avoid paying so much interest?

Most loans assume one payment per month, with about an average of 30 days between each payment. Interest is accrued daily based on the principal balance, so if you pay once a month you are paying a full 30 days of accrued interest on a set daily interest rate. If you only pay on your due date, you are paying within the terms of the original loan amortization schedule. This means you are paying the full amount of anticipated interest (If this is confusing I do have an example that hopefully clears it up below).


However, if you make payments between each due date you will reduce your average principal balance which will reduce your interest owed overtime. Which will reduce your total interest paid by the end of the loan’s term as well. 


There are a few ways to do this. You can split up your payment amount over the billing period. For example a $400 payment can be broken up into two $200 payments in one month, or four $100 payments. As long as you’ve made the full expected payment amount before the payment’s due date, you are set. Some banks may not accept “early” payments, so consult your bank before committing to this payment process to avoid late fees or missed payment penalties.


Another way is to make the standard payments, but throw extra cash at the loan during the 30-day billing cycle. So if you have a $400 loan payment, between your payment dates try to put an extra $50 or $100 to the loan. This will reduce the interest paid and shorten the term of the loan. The amortization calculator I linked above allows you to input additional payments. Test it out to see how it all shakes out.


Fun fact: On a standard 30-year mortgage paying just one extra mortgage payment a year can cut 5 years off the term of the mortgage. 


There are plenty of apps, calculators, and online debt management services that can help you design a debt pay down strategy. I’ve seen some cool apps that even let you simulate extra payments toward your loans to show you how it’ll help you conquer your debts! I’m not sponsored or anything but I saw You Need a Budget’s demo (YNAB) on this exact feature and it was so cool.


Principal Only Payments

A lot of people don’t know this, but you are allowed to pay more than the standard payment amount for your credit accounts. We’re not talking about credit cards, but let me take it there for a second. I was working with someone who wanted to tackle their credit card debt and they asked me if they could really pay more than the payment amount listed on the statement. I was like “Yes, do it immediately and as often as possible!” 


Helloooo, the banks want to make money. 


How do banks make money? By charging you interest. How do they ensure you pay the maximum interest? They coerce you to follow their amortization schedule or only pay the “minimum amount required” on your billing statements out of convenience. The worst part is most people love the idea of minimum balances or lower payments because it makes their monthly budget easier. What we don’t realize is over time we are losing so much more money and will be in debt longer! 


Credit cards, lines of credit, loans, you name it! If it charges interest the banks don’t want you paying more than the payment amount listed on the bill. The loan game changer, and the fastest way to chunk down a loan, is to make principal only payments. That money will apply directly to the principal balance and accelerate the paydown of the loan dramatically. Keep in mind, it does not not affect the accrued interest total. 


Example:

I have a $4,000, 5-year (60 month) term loan with an 11% APR. The daily interest accrual on my loan is $1.21 (=4,000*0.11/365). I have accrued 20 days of interest and am 10 days away from my first due date, so I owe $24.20 of interest. I just got this loan last month so I have the full term to pay through.


Today I got my tax return back and wanted to put some toward the loan. I called the bank and asked to make a principal only payment of $700. The payment is processed and my loan balance is updated. This changes the amount of daily interest accrued from $1.21 to $0.99 (=3,300*0.11/365) effective immediately. For the next ten days in my billing cycle I saved myself $2.20 in interest. Because of this one extra payment I can now pay my loan off in 3 years and 11 months, saving $434 in interest! I will probably do the same next year and see how much sooner I can pay off my loan.


Note: depending on your bank you should be able to make principal only payments online, over the phone, or even in their app.


As we discussed above, reducing your principal balance means you reduce your interest owed. Reducing your interest owed means you get to pay less on the overall loan. The best part is you end up reducing the life of your loan because you are paying more than the agreed upon terms. Remember, the amortization schedule ensures you pay all the interest and principal owed in the agreed timeframe. If you pay the principal off faster, and reduce the interest owed, you are paying the loan off sooner. That means you can be debt free faster.


That’s music to my ears!


Why can people make payments on loans but owe MORE than they borrowed after ten years?

It all goes back to amortization schedules and minimum payments. Because this is a common occurrence for people who have large amounts of student loan debt I want to focus on that scenario for my example. This is my honest opinion: people get swindled into thinking they’re on an affordable income payment plan after graduation. They’re really not. Let me explain.


When you accept an adjusted payment plan, the financial institution just reduces the minimum payment amount required on your bill. This just means you don’t get late fees or penalties for not being able to make the real payment amount. It doesn’t actually change how much interest is accruing. And it certainly doesn’t change the payment amount needed to actually pay down the loan in a reasonable time frame.


Let’s say you accepted one of these “affordable” payment plans. You could make 10 years of adjusted minimum payments and never pay a cent to the principal balance. The “budget friendly” payment plans usually only ever cover the interest owed to the financial institution for each billing cycle. Don’t believe me? We can walk through a real life scenario: mine.


I’ve officially graduated from college as of 2023 after 8 years of schooling, 2 gap years, and acquiring several degrees. I know, I’m insane.


I have just a bit over $50,000 in remaining student loan debt. I’ve already paid off about $30,000 in private student loans. Bonkers I know. My remaining loans are all through FAFSA. The average interest rate across all my loans is about 3.6% and I have an estimated term of 10 years now that I’m actively paying on them. I ran that through the amortization calculator and the results are depressing!


To pay all of my student loans off in 10 years I need to make a monthly payment of $500 for the next 10 years. With no additional payments toward the principal, I would also be paying nearly $10,000 in interest during the life of the loans. 


Let’s say my student loan provider decided to accommodate my income and only requires me to make $250 payments per month. Remember, they are only adjusting my required payment amount. They are not modifying how much interest is owed or the remaining principal balance. In a one month period my interest will be around $150 and remain around that amount until I’ve dropped my principal balance considerably. 


With a $250 payment and $150 owed in interest, that means only $100 will be applied to my principal balance. After one year I may only be able to pay $1,200 to my principal while paying $1,800 toward my interest. Can you see how painful this is? Imagine if I’m accommodated to a $100 monthly payment plan. Imagine if I had a higher principal balance!


Let’s take it to the broader U.S. population. The average student loan debt for public attendees is about $39,000 upon graduation. The average undergraduate interest rate for FAFSA loans is about 5.5% and most FAFSA repayment plans are recommended to be 10 year plans. 


Students who graduate this year will need to make monthly payments of $423.25 to successfully pay that loan off in ten years. They will be paying a total of $50,790.30 because their interest will total $11,790.30. If they wanted to pay only $280 a month they’d be paying their loan back for at least 18 years and giving up $20,000+ in interest to the bank. This is why understanding amortization schedules is so important! 


Takeaways of paying down loans

What I hope to leave you with is two major things when you think about paying down your loans.


  1. Understand what an amortization schedule is and what it means to you as a borrower. Every term loan will have an amortization schedule. Adhering to the schedule is the bare minimum obligation you are signing up for when you sign the loan contract. Know your rights and know how to save yourself money in the long run.


  1. Do not fall for promises of affordable loan payments or flexible term loans. Not locking in a fixed term means there is no set amortization schedule. The bank can fluctuate your required minimum loan payments as you request and trap you in a blackhole of accrued interest. The same goes for affordable loan payment plans.


If you run into financial hardships it may be in your best interest to seek financial help. Applying for forbearance, deferment, or bankruptcy may be better alternatives than accepting a life of unending loan debt because of compounding interest.


On a less scary note, almost every loan that you can take out is a fixed-term loan and most banks won’t let you have a loan term longer than 10 years unless it’s a mortgage. So that’s a breath of fresh air.


To my readers please be smart, seek out all the information you can, and do what’s best for your wallet and peace of mind.


Author’s note: I hope my posts are helpful. I try to break these things down in a way that is easy to read and understand. I appreciate any feedback on how to improve, so feel free to leave a comment below. If you are simply enjoying the content, I’d love to hear about that as well!


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