National Emergency Forbearance
As part of the CARES Act signed on March 27, 2020, individuals with federally held student loans are eligible for certain relief. Interest rates on federal student loans have been temporarily reduced to 0%. Payments on federal student loans have also been automatically stopped from March 13, 2020 through September 30, 2020. For some, this relief is necessary and comes not a moment too soon. If you are having trouble paying your bills or have experienced a change in your employment situation, having your loans placed in National Emergency Forbearance will offer you a chance to focus on other financial priorities.
But what should you do if you are still working and can continue to afford your student loan payment? Should you take advantage of this 6-month break? Or should you continue to pay or even increase your payments?
With interest rates reduced to zero for the next 6 months, your student loan debt will not grow. With the fixed 0% interest rate, any payments you make during this time will be applied directly to the principal once all interest that has accrued prior to March 13 is paid. This gives you the unique opportunity to lower the amount you owe in the long run.
Paying Towards Principal
If you make payments directly towards the principal, you will lower the overall cost of your loans over time. To see this, let’s look at a simple example.
If you owe $10,000 on a student loan with a 5.8% interest rate (the average student loan interest rate) and you have 10 years on your repayment, your monthly payment would be $110.02.
Over a 6-month time period where you are being charged interest you would pay $660.12. Of this amount, $285.50 would be interest. Over the total 10 years of the loan you would pay back $3,202.26 in interest
If over the same 6-month period where your loan was accruing 0% interest, and you made your $110.02 monthly payment, you would pay the full $660.12 towards the principal of the loan. This would lower your loan balance to $9,339.88 for the remaining nine and a half years in repayment. If you continued to pay your original payment of $110.02, you would pay this balance off in just over nine years, knocking six months off of your repayment period. You could also lower your monthly payment to $106.76 and pay the loan off over the remaining nine and a half years. If you took the full 10 years to pay off this loan with the new lower monthly payment and the original 5.8% interest rate, you would pay $2,830.28 in interest, which would save you $471.98 in interest over the life of your loan.
How to Apply Your Payments
If you are still able and would like to continue paying on your student loans, you will have to go in and make your payments each month (even if you were previously signed up for automatic payments). When you do this, you can apply your payment across all of your loans (if you have more than one) or target a specific loan.
There are two schools of thought on how to target your payments. They are the debt snowball and the debt avalanche.
The debt snowball is a debt repayment method where you make the minimum monthly payments on each of your debts, then apply whatever is left in your budget for debt repayment to the debt with the smallest balance. This accelerates the payoff of your smallest debt and once it is paid you move to the next smallest. With the debt snowball, because no payments are due during this forbearance, you would apply your entire monthly student loan payment during this time to your smallest student loan to try to eliminate it. If you can eliminate it during the 6-month forbearance period, then you would move on to paying towards your next smallest loan.
The debt avalanche is a debt repayment method where you make the minimum monthly payments on each of your debts, then apply whatever is left in your budget for debt repayment to the debt with the highest interest rate. So, during National Emergency Forbearance, you would apply your full monthly student loan payment towards your loan that, when original interest rates are in place, has the highest interest rate. If multiple loans have the same interest rate (normally), you can pay towards the largest loan to save the most once interest rates are reinstated.
Either of these strategies are good ways to pay down your debts. During this time when your student loan interest has been temporarily set to 0% and no payments are due, utilizing either method to pay down some of your student loans will help you get ahead in the long run and will help you pay less over the life of your student loans.
NOTE: To double check on the status of your student loans, log on to your account with your student loan servicer. If you still see payments due, check in with your servicer on the status of the program. For additional information on the program click here.