By Joseph Reinke, CFA
This article is a follow up to a recent Facebook post we published about Great Lakes and includes what we’ve seen from those that have used our FitBUX Tracking Solution. (A heads up: This article gets into some technicalities so I highly recommend discussing this with your FitBUX Coach.).
“I called Great Lakes again and they are supposed to be reapplying the payments, again. The last person I talked to said the person I spoke with last week entered everything “right”, yet the payments were still not applied correctly.”
We hear this daily from FitBUX Members….so, what’s going on here?
Let's take a step back. When you are making prepayments to save money and pay off your student loans faster, there are 2 key elements to make sure you are doing so in an optimal fashion:
First, how your prepayments are allocated. The different student loan servicers sometimes get this wrong. If they do, it will cost you thousands of dollars over the life of your loans.
Second, timing is critical. You need to carefully pick the day of the month you’re making your prepayment. Similarly, this may cost you thousands not done correctly.
So, if your prepayments are misallocated and done on the wrong day…you get the idea…it could be very costly when it’s all said and done.
Required monthly payment vs. discretionary prepayments
- Your total required monthly payment is the payment you have to make each month. That required payment is split into two parts: an interest amount and a principal amount. The interest amount covers how much you owe in interest each month. The principal amount is applied to your loan principal and reduces your overall balance. (Click here for a video on How A Loan Works).
=> You can’t choose how the required payment is allocated across your different loans, i.e. you can't apply your required monthly payment to your highest-interest loan first.
- A prepayment is an amount you elect to pay above your required monthly payment. The point of the prepayment is to reduce how much you owe at a faster pace. Therefore, you pay less interest in the long-run.
=> You DO control which loan(s) you want to apply your prepayment first. That’s good news.
Intuitively, it would make sense to make your prepayments as often as possible to optimize your savings. However, based on how student loans (and other loans) work, that may not be the case unless you time these prepayments perfectly.
The best way to get into the next level of details is to use an example of who Great Lakes allocates prepayments.
- You have multiple loans all at different interest rates.
- Your total required monthly payment is $1,100.
- Of the $1,100 monthly payment, $900 is applied to reduce principal while $200 will be used to pay interest. This $900 number is the one you want to remember.
- Great Lakes has a “billing cycle.” This billing cycle ends the day your required payment is due and starts over the next day. For this example, let’s assume that the billing cycle ends the 30th of each month.
- You pay your required monthly payment on the 30th of each month, using the auto-pay feature Great Lakes offers.
- Your next payment is March 30th.
- You decide you want to make a prepayment of $300 on March 20th and you want to apply it to your highest interest rate loan first., as this will save you the most money.
According to Great Lakes, they “have to apply your payment first to satisfy your required payment for the given billing cycle. Then any amount above that goes to reduce to the loan of your choice.”
What this means for your prepayment: Since that $300 prepayment is made on March 20th, it will be considered as a portion of your required monthly payment for the billing cycle ending on March 30th and will be applied against the principal portion of your required monthly payment for that billing cycle.
In other words, what you thought was a prepayment on March 20th, will NOT be applied against the highest-interest loan first.
What this means for your required monthly payment: Your $1,100 required monthly auto-payment is made on March 30th.
Since the $300 payment you made on March 20th was applied as a payment against the principal for the billing cycle ending on March 30th, Only $600 of your required payment is used to satisfy the rest of the principal portion of your required payment ($900 less the $300 you already paid).
In essence, the remaining $300 of your required monthly auto-pay will be treated as a prepayment against your loans’ principals but only on March 30th.
This cost you money by applying the pre-payment on March 30th as opposed to March 20th. Of course, making your prepayment after the end of your March billing cycle won’t help either since that payment would be applied to your required payment for your April billing cycle…
Time is money, but this money is going into the lenders pocket, not yours.
It gets worse...
By default, loan services do not always allocate the portion of a payment made by auto-pay to a specific loan. So the $300 “left over” from your previous required payment you thought you could apply to your highest-interest loan is not happening.
In summary: by default, your prepayments are applied later than you’d like AND they are not always applied the way you want them to be.
Great Lakes has told us to have FitBUX Members make their prepayment targeting a single loan on the same day as their required auto-payment but as a separate payment.
But there is one more scenario that keeps things “interesting”. If your auto-payment happens to fall on the weekend or holiday you won’t be able to make your prepayment the same day as your scheduled auto-pay.
In that case, you will want to make your prepayment the last business day before your auto-pay is scheduled and then call Great Lakes the first business day after your auto-pay was made to have them apply your prepayment correctly.
Also, Great Lakes has a relatively new technology that allows you to specify how any prepayments should be applied and we highly recommend you set this up in advance.
The FitBUX Student Loan Tracking Solution
As you can see, this is a topic that can get really messy, really quickly. In addition, when one of your loans is paid off, you will have to go through all of this again because the loan servicers don't drop your auto-payment (this is another topic of discussion for another day).
Our FitBUX Tracking Solution customizes your student loan repayment strategy, keeps track of your progress and flags errors when they occur. In addition, our FitBUX coaches are available to answer questions you have major life events over time (starting a family, buying a home etc) which could require adjustments to your student loan repayment strategy.