• Ryan Himes

Paying Off Loans

There's actually a science to making loan payments; maybe it's more of an art. Loans are designed so that the first payments made on them are almost entirely interest. This can be seen as after one year of paying off a 30-year mortgage, the balance of the loan is not 29/30ths of the original loan. Truth be told, the balance is probably only minutely lower. How is that? The first payments on the loan pay off the interest first; the balance of the loan hardly changes.

There is a way to do it differently. Instead, after making a monthly payment, a person can make an additional payment and have it applied directly to the principal (the original amount borrowed). Once the principal is paid off, the balance of the loan is zero and the loan is effectively paid off.

Occasionally loan providers will explicitly prohibit additional payments onto the principal, which is something the borrower should look into before accepting the loan. NOTE: Once the paperwork has been signed, there isn't much that can be done on behalf of the borrower to change the terms of the loan.

Usually, a borrower will need to declare bankruptcy in order to restructure the terms of a loan. Unfortunately for most millennials and Gen Z with student loans, a borrower is unable to declare bankruptcy on a student loan. The inability to declare bankruptcy alongside sky-high interest rates (usually 2x to 3x mortgage rates) are among the reasons that student loans are considered predatory.

Incredibly high interest rates with low scheduled monthly payments usually means that a person can make 3-5 years worth of payments and not see the balance on the loan change at all. This is because the monthly payments are so low that they don't even cover the interest due, which causes a rollover effect that can continue for years. Some, but not all, student loans will likely take more than one lifetime to repay; and in those instances it's not uncommon for the loan agreement to state that the debt will carryover to next of kin.

A rule of thumb for paying off debt of any kind, pay it off as quickly as possible. And make additional payments directly applied to the principal as often as possible. A loan doesn't exist for a certain number of years; a 30-year mortgage can be paid off in 3 years if the principal is paid off. And the sooner the principal is paid off, the less interest the borrower will end up paying.