Student Loan Amortization: How Does It Work?

More than half of undergraduate students leave school with an average debt of $29,400, according to the latest figures from the College Board. When it's time to repay, your loans are generally paid off through a process called amortization. While it might sound complex, amortization is simply repaying the loan, including interest, in equal monthly payments based on a set schedule.

Here's what you need to know about how student loan amortization works.

Are student loans amortized?

Yes, most student loans are amortized. Like car loans or mortgages, student loans are installment loans, meaning you borrow a set amount and repay it over time with interest through monthly payments. Each payment is divided between interest and the loan principal, which is the original amount you borrowed.

Amortization determines how much of each payment goes toward interest and how much reduces your principal balance. This process continues throughout the life of the loan until it's fully repaid.

How does amortization work for student loans?

With student loan amortization, each monthly payment is split between interest and principal. Early on, when your loan balance is higher, more of your payment goes toward interest, while a smaller portion reduces the principal. As you pay down the loan, the balance decreases, and a larger share of each payment goes toward reducing the principal.

By the end of your loan term, most of your payment is applied to the principal. Following the set payment schedule ensures you pay off the loan in full by the end of the term.

Your amortization schedule depends on your repayment plan. Federal student loans offer several options, from the standard 10-year plan to income-driven plans that extend repayment as long as 25 years. Private loans have different schedules depending on the lender, with repayment terms typically ranging from five to 20 years.

Student loan amortization example

Let's say you borrow $12,000 in federal student loans at a 6.53% fixed interest rate and you choose a 10-year repayment plan. Over the 10 years, you'll pay $16,372.90 in total, with $4,372.90 of that being interest. Your monthly payment would be $136.44.

At the start of the loan, your payments are nearly evenly split between interest and principal, so the loan balance decreases slowly. As time goes on, more of your payment goes toward the principal, and the balance drops more quickly each month. The table below illustrates how these shifts occur throughout the repayment period.

Keep in mind, if you've taken out multiple loans over your time in school - whether federal or private - you'll likely have different amortization schedules for each. This means you'll need to track multiple payments each month.

However, consolidating your federal loans or refinancing your private loans can simplify things by combining them into a single monthly payment. Just avoid refinancing your federal student loans if you plan to take advantage of benefits like income-driven repayment and loan forgiveness.

Federal vs. private student loan amortization

Federal and private student loans follow different amortization schedules. Federal loans offer a range of options, some designed to provide relief for borrowers who may need flexibility:

• Standard Repayment Plan: When you take out federal student loans, you'll be automatically placed on this plan. Payments are fixed over a 10-year term unless you choose another plan.
• Graduated Repayment Plan: This plan also uses a 10-year schedule, but payments start lower and gradually increase over time.
• Extended Repayment Plan: This plan is available if you have more than $30,000 in outstanding loans. It stretches your payments over 25 years.
• Income-driven repayment (IDR) plans: IDR plans base monthly payments on your discretionary income, potentially offering a lower monthly bill. Any remaining balance is also forgiven at the end of the repayment term.

Private student loans, on the other hand, come with their own schedules set by the lender. Repayment terms typically range from five to 20 years, and interest rates - whether fixed or variable - are often higher than federal loan rates.

Most private lenders offer a 10-year repayment term, but some provide flexibility. For example, some lenders allow you to extend the repayment period in certain situations, like Abe, which offers a five-year extension under specific circumstances.

Check Out: How To Get Student Loan Repayment Help

Current student loan refinance rates

Benefits of student loan amortization

• Flexible repayment options: Both federal and private student loans can offer flexibility in how you repay. Federal loans provide several repayment plans, including income-driven options that adjust your payments based on your income. Most private lenders also let you choose your repayment term and some may even offer relief options during times of financial difficulty.
• Predictable monthly payments: If you opt for fixed-rate student loans, one major advantage of amortization is the stability of your payments. With fixed interest rates, your monthly payment remains consistent, making it easier to plan your budget.
• Option to pay off early: You're not locked into the amortization schedule. If your budget allows, you can make extra payments to pay off your loan faster. By doing so, you'll reduce the amount of interest you pay over time.

Challenges of student loan amortization

Student loan interest behaves a little differently than other types of amortized loans like a mortgage or car loan. There are a number of reasons why.

• Interest accrues during school and grace periods: You aren't required to make payments while you're in school or during your 6-month grace period, but interest on most federal and private loans accrues daily during this time. If unpaid, this interest adds up quickly. Making interest payments while in school can save you thousands in the long run.
• Interest capitalizes after deferment or forbearance: When you pause payments through deferment or forbearance, any unpaid interest may capitalize, meaning it's added to your principal balance. This increases the amount you owe and causes you to pay interest on a higher loan balance, leading to larger payments down the road.
• Negative amortization risk: Some repayment plans, particularly income-driven options, can lead to negative amortization. This happens when your monthly payments are too low to cover the interest, causing your balance to grow even though you're making payments.

FAQ

What does it mean for a student loan to be amortized?

An amortized student loan is repaid in equal monthly installments over a set schedule. Each payment covers both interest and principal, with amortization determining how much of each payment goes toward interest versus reducing the principal balance.

Are federal student loans amortized?

Yes, federal student loans are amortized. Like other installment loans, you borrow a lump sum and repay it over time in fixed payments, which cover both interest and principal.

Can I pay off my student loans faster than the amortization schedule?

Yes, you can pay off your loans faster by making extra payments. This reduces the total interest you'll pay and helps you pay off the balance more quickly. Just ensure the extra payment is applied to the principal, not just the accrued interest.

How does interest affect amortized student loans?

Interest on student loans accrues daily, and if your payment doesn't cover the interest — such as with income-driven repayment plans — your balance may grow, even if you're making regular payments. This is known as negative amortization.

Are private student loans amortized differently from federal loans?

Yes, in some ways. Private loans often come with different interest rates based on your credit score (or your cosigner's), whereas federal loans have a set interest rate for all borrowers.