The Liz Repayment Plan

In the comments of the post above, Liz discusses how she beats the system with her repayment plan. Liz sent in a detailed explanation of the how her repayment plan works. Here it is:

The rules on student loans ARE different from most other consumer debt – the banks compound the interest daily, based on the total principal FOR THAT DAY.

And when the debtor makes the monthly payment, the banks can apply the payment FIRST to interest, based on the NUMBER OF DAYS since the last payment. The thing is, that proportion changes every month, which affects your principal outstanding, which in turn affects your daily interest charge.

So say your bill is due the 8th of the month, and you make your payment on the 3rd one month, but the 6th the next month. They’ll calculate the portion of your payment that goes to interest based on 33 days (in a 30-day month), and whatever the total principal is the day the payment is applied. Whatever is left over after covering 33 days of interest will be applied to principal. So you’re paying a little less in principal some months. And they’re calculating your daily interest based on the higher principal. So the next month maybe a little more goes to principal, but not necessarily enough to make up the difference in carrying a higher daily balance on a six-figure loan. Get it?

It’s not like other loans I’ve had, where I just make the payment and the same amount goes to interest every month. With this calculation, the debtor can never pay more than 365 days of interest a month, butthe debtor CAN pay interest calculated on a higher principal several times during the year. And the slightly larger portion of some payments going to principal a few months per year will NOT make up the difference.

That’s why the loans keep going up even for students keep making the payments. You actually have to pay extra every month just to keep the loan from growing, because they’re calculating your interest based on the principal outstanding EVERY DAY. And some months you’re not lowering principal as much as others. Subtract a few annual fees from your payments, including, ironically, “default insurance,” and you have a loan that will just never go away, even for a responsible borrower who makes every single payment.

Anyway, I have no problem paying my debts. I borrowed the money expecting to pay it back. But I do think this system of calculating interest is about as messed up as everything else about the legal instruction industry right now.