What if I told you that you could pay off your student loan debt faster by making payments before your first bill. Would you take advantage? While most recent graduates let this small window of opportunity pass them by, using your student loan grace period wisely can be a game changer when it comes to debt repayment.
Did you know that making payments during your student loan grace period can significantly reduce your debt? The student loan grace period is the period between graduation and when your first payment is due. On average grace periods last six months but it’s important to note that not all student loans have grace periods. Actually, most private student loans do not offer grace periods. Always confirm with your lender for details.
Although grace periods give you time to find a job and figure out your finances, don’t be fooled. This so-called “break” doesn’t come cheap!
Types of Loans With Grace Periods
Loans with Grace Periods
- Direct Subsidized Loans
- Direct Unsubsidized Loans
- Subsidized Federal Stafford Loans
- Unsubsidized Federal Stafford Loans
- Perkins Loans
Types of Loans Without Grace Periods
Loans Without Grace Periods
- PLUS loans
- Private loans (depends on lender)
Student Loan Grace Period
Negative Effects of Capitalization
During your grace period watch out for accrued interest.
Student loans accrue interest daily. As a result, the amount you owe grows every day. Unlike short-term Smart-Pig student loans that have interest caps, these have no limits. Rain or shine interest accrues. Even if you run into financial trouble, you’re still responsible for paying the interest.
But here’s where things get hairy.
Right before your first bill, any unpaid interest is capitalized (added) to your principal. After your interest capitalizes, you pay interest on a higher principal amount.
Interest capitalization applies to unsubsidized loans. It does not apply to subsidized loans.
Principal + Interest = Inflated Principal
This negatively affects your student loans because it increases your debt. Essentially this creates a snowball effect where you pay interest on interest.
Capitalization in Action
Let’s say you owe $20,000 in student loan debt.
If you don’t make any payments over the six month grace period, your loan accrues $1,000 interest.
When your first payment is due, your new principal amount will be $21,000 ($20,000 principal + $1,000 interest). Capitalization adds unpaid interest to your principal.
Going forward, you’ll have to pay the interest on $21,000 instead of $20,000.
How To Avoid Capitalization & Reduce Debt
As soon as your student loan grace period starts, make payments right away. Pay off your interest before it capitalizes. This may include a monthly lump-sum payment or payments as interest accrues.
If possible, make payments that at least cover the daily interest. If you can afford a bit more, pay off the interest and some principal.
No matter how small, these extra payments will help you make strides towards repaying your debt. The less you owe, the less time you’ll spend repaying.
In the long run, if you can avoid capitalization, it will help you save time and money.
During my grace period, I regularly made payments towards my interest. However, I couldn’t afford to pay it all. Overnight, my $60,000 loan grew to $63,000. Yeah, lesson learned!
Whatever you do, try not to wait to start making payments until your first bill. You’ll have plenty of time to take a “break” when you’re debt free.
Did you take advantage of your student loan grace period?
Author: Danielle Desir
Danielle Desir is a Travel Finance Strategist that uses her financial background and knack for financial planning to empower those who want to travel afford travel and excel in their personal finances. She shares creative planning strategies, saving tips, cheap flight deals and even talks about her student loan repayment journey. Her financial expertise has taken her across the globe to over 22 countries and 3 continents (and counting), all while paying off her student loans, saving for a house, owning a home, and working full-time.
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