Thursday, December 4, 2014

Adultification II: Loan Repayment (IBR) and Capitalization of Interest

I had a lot of assumptions about how money, interest, payments, etc were handled, and they were all slightly incorrect in one way or another. Here's my voyage of error and education.

First, my loans entered repayment 6 months after graduation, which was roughly December 2013. I believe I was previously aware of the possibility of gaining what's called "forbearance" on loans, (probably from a phone call to the loan servicer before the repayment period began) which allows you to pay less, or wait to pay, while you are in a difficult financial situation.

The standard repayment option for my student loans owed to the Department of Education was $350/mo. The interest alone is $170, roughly. But under the Income-Based Repayment (IBR) option, I'm allowed to pay nothing, so long as my yearly income is less than my total debt. On minimum wage, that's a given.

In the mean time, I had asked for the loans to be placed on "administrative forbearance," where I wouldn't get penalized for not making payments, but I had to still make an official IBR plan request. I got around to this by July of this year. Nevertheless, I was tantalized by the idea of getting an income tax refund for the interest I paid to the loans, so I set about to mail checks to pay the interest during that time period anyway.

And last month, when I set about to calculate how much I was paying of interest and principal, I found some upsetting numbers.

On not a single month was the full amount of the accrued interest paid! And tallying up the total interest paid, I calculated that a full half of the money I'd sent had gone to principal, rather than the interest on every loan group, which I'd specifically requested in the special payment instructions. (I had sent a little more each month, to go to the principal on the loan group with the highest interest rate, but not nearly half of each check) What was going on?!

This was my mistake. I had made three false assumptions.

  1. That interest was capitalized monthly. (Capitalization is when interest gets added to principal, which is what is used to calculate how much interest you'll 'earn' on subsequent statements) Perhaps it's different for different loans, but if I understood my call-center lady correctly, the IBR plan never capitalizes interest, but keeps it separate from principal, for as long as you remain on the plan and as long as you don't "reallocate" the interest/principal.
  2. That interest accrued monthly. I knew that the interest rate was a yearly rate, but I had not considered that the loan holder calculated additions to the interest on a daily basis. That's why, when I mailed my checks ahead of the due date, the full amount of interest shown on the statements had not accrued yet, so I was sending them more money than there was interest, and the remainder was being put to principal.
  3. That the payments I mailed would be deposited on the due date. See above. Payments received were applied on the same day, and if I had wanted it differently, I should have made payments over the phone or via the internet.

And further, something I was unaware of, that really threw me off: After my IBR request went through, the Department of Education got rid of--not paid, but simply erased--any interest that had accrued up to that point on every loan, as of the August statement. Considering that I had been paying interest all along, this didn't accomplish much, except to make my entire next deposit go completely to principal. That really threw me for a loop.

Despite all of these explanations, there was still unpaid interest for nearly every month except one, according to my loan adviser girl. Neither of us had a clue why that was so. Payments for one month could not be moved to another month, but she told me that she could put in a "reallocation request," to move principal for each month to pay the remaining unpaid interest for said month. August would seem to be the odd man out.

As the principal gets reallocated, that would raise the loan balance, thus raising the amount of interest that accrues each month, and so on and so forth. This has the consequence of making the loans more expensive in the long term, especially in the event that I don't make interest payments. But the whole incentive for me to make these large payments was because it is only interest that can be tax-deducted in 2015, not the principal. That money would be money I gave away, not to get back. I was paying down interest with the expectation that it was money I was going to get back, so in other words I was essentially not spending any money, all I would have to do is wait until April 2015 to have those funds available again.

And now that that's resolved, I should soon be able to log in to see what the final count of my paid principal and interest is, online, and I'll definitely keep myself to electronic payments in the future to avoid possible fiascos. The daily accruing interest will be higher as a result of this reallocation, but I'll be able to get the maximum amount of money back from the Feds that I intended.

~ Rak Chazak

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