Are Student Loans Amortized?

Student loans are one of the fastest-growing debt categories in the United States. According to the New York Federal Reserve, Americans owed more than $1.58 trillion in student loans as of Q3 2021. In fact, the average student debt amounted to $32,731 per person in 2019.

However, a lot of people still don't know the basics of student loans. That's because there's a lot of misinformation out there. So before you apply for your student debt, it's important to understand how they work including what you'll have to do when it comes time to pay your loans back. This article looks at what it means for a debt to be amortized and how your student loan fits into that definition.

Key Takeaways

  • Amortization refers to the term or process of paying down debt like a loan or a mortgage.
  • Student loans are generally amortized because they are installment loans with regular payments.
  • Payments are divided into principal and interest payments.
  • Borrowers can get the better of their amortization schedules by making extra payments or even refinancing if it makes sense.

Amortization Defined

You've probably heard the term amortization while you're at the bank. But do you know what it means? The term amortization is often used to refer 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—bi-weekly 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 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.

When you start repaying your loan, the majority of your payment goes toward interest.

Amortization Example

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 balance is $20,000 and the $377.42 payment is made. Based on the mathematics of the amortization, $294.09 of this amount 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.

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. In the earlier years of repayment, a larger portion of the monthly payment is applied to the interest due rather than the principal.

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. But this happens later on—earlier payments pay more interest than principal.

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 principle, 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. 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 principle of the loan.

Getting More From Your Amortization

Don't want to be controlled by your student loan's amortization period? There are a few ways you can get yourself ahead of the game. First, consider paying more than just your minimum or required payment. So if you owe $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.

Another way to tackle your amortization period and cut it down is by making extra payments as we mentioned above. Again, paying more than your required payment will cut down the principal balance quicker and reduce the amount of interest you'll owe.

And 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

The Bottom Line

Student loan amortization can make it seem like you’re not making any progress in 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.

Article Sources
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  1. New York Federal Reserve. "Center for Microeconomic Data: Student Debt."

  2. National Conference of State Legislatures. "A Legislator's Toolkit for the New World of Higher Education," Page 2.

  3. Federal Student Aid. "The Standard Repayment Plan Is the Basic Repayment Plan for Loans from the William D. Ford Federal Direct Loan (Direct Loan) Program and Federal Family Education (FFEL) Program."

  4. Consumer Financial Protection Bureau. "What Is Negative Amortization?"

  5. Federal Student Aid. "Student Loan Forgiveness."

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