Are Student Loans Amortized?

Student loans are the second-largest growing debt category in the United States, and many people still don’t understand the basics of how they work. That’s because there’s a lot of misinformation out there.

Before you apply for your student loans, it’s important to understand what it means for a debt to be amortized and how your student loan fits into that definition.

Understanding Amortization

Amortization refers to the term or process of paying down debt, like a loan or a mortgage. So a 30-year mortgage has an amortization period of 30 years. Payments are normally made at regular intervals—biweekly or monthly—and include both principal and interest.

A loan or mortgage’s amortization period or schedule starts with the full balance of the debt. Lenders then calculate the payments over the lifetime of the loan, including the principal and interest. When repayment begins, payments cover more interest than principal. But as time goes on, more of the borrower’s payments go toward paying down the principal to the point that the debt is paid off in full.

Is Your Student Loan Amortized?

The short answer is yes. That’s because it’s an installment loan just like other similar debts. Student loans are one-time loans, meaning they are not revolving and you can’t re-borrow money that you have already paid back. Thus, they are amortized.

This means that each month a payment is made, a portion of that payment is applied to interest due, while another portion is applied to the loan principal. With each payment, the loan gets smaller.

But remember, although your payment remains the same until the end of the loan, the dynamics of your payments change. With the passage of time, more of your payments go toward paying down the principal.

Example of Amortization

Private organizations such as Sallie Mae or Discover usually issue longer-term loans. For simplicity’s sake, the following example assumes only a 60-month loan. Assume a $20,000 loan with a 5% interest rate that is repaid in 60 equal payments. The monthly payment amount is $377.42.

In month one, the starting loan balance is $20,000 and the $377.42 payment is made. Based on the mathematics of amortization, $294.09 of this payment is applied to the principal, and $83.33 is applied to interest. The ending balance on month one is $19,705.91. In month two, $295.32 of the $377.42 payment is applied to the principal, and $82.11 is applied to interest. The ending balance on month two is $19,410.59.

The proportion of the monthly payment applied to the principal slowly increases, and the amount applied to interest decreases. By the 60th month, the opening balance is $375.86. During the month, $1.56 of interest is charged, bringing the amount due to $377.42. This allows the entire payment to take care of the remaining balance.

Make Amortization Work for You

Amortization can discourage some student loan borrowers. That’s because it means more of each payment is applied to the interest due on the loan early in the repayment period. As a result, the balance, or principal, owed decreases slowly, making the borrower feel as if little progress is being made toward the repayment of the loan.

In some cases, the borrower’s monthly payment may not even cover the amount of interest due, which is known as negative amortization. This causes the loan balance to increase rather than decrease.

Borrowers with negative amortization may still be able to qualify for student loan forgiveness through the Public Service Loan Forgiveness (PSLF) program or an income-driven repayment (IDR) plan. Borrowers can avoid negative amortization and pay off their student loans faster by paying extra each month or by making extra payments. When doing this, however, it’s important to specify that excess payments be applied toward the principal of the loan.

Getting More From Your Amortization

If you don’t want to be controlled by your student loan’s amortization period, there are a few ways to get yourself ahead of the game.

First, consider paying more than just your minimum or required payment each month.

For example, if your payment is $350 each month, consider making a $400 payment instead—provided you can afford it. But before you do, make sure you let your loan company know that you want the extra money to go toward the principal. You don’t want those funds to be counted toward your next payment. Paying more than your required payment will cut down the principal balance quicker and reduce the amount of interest you’ll owe.

Second, don’t forget that you can refinance your loan—but only if it makes sense for you.

For instance, you don’t want to give up any benefits that come with a federal student loan, such as future loan forgiveness or interest payment deferrals in the case of subsidized loans. If you have a private loan, though, refinancing may cut your interest rate, which means you will have a smaller monthly payment and pay less over time.

The Bottom Line

Student loan amortization can make it seem like you aren’t making any progress toward paying off your loan. But amortization is normal for installment loans like student loans, auto loans, and even mortgages.

Pay extra on your loans to reduce your principal faster, and avoid negative amortization.