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Ask Dr. Don

Student loan repayment

Dr. Don,
I am a graduate student with $44,000 in student loans. Some loans are subsidized, with the government paying the interest while I'm in school, while others are unsubsidized. Since I am a currently enrolled student, no payments are due at this point. I pay $150 to $200 a month anyway because I don't want to be saddled with too much debt once I finish school.

Here's my question: Is it better to have my entire payment go to the unsubsidized portion of my debt or for the payment, once the interest on the unsubsidized is paid, to be split between the unsubsidized and subsidized loan amounts?
Savvy Student

Dear Savvy,
Interesting question. My recommendation is to put all of the money toward paying down the unsubsidized loans.

Here's why: Even though no payments are due while you're in college, interest is accruing on the unsubsidized loans. In finance terms the loan is capitalizing interest or adding interest to the outstanding loan balance.

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Your approach of making monthly payments on the unsubsidized loans equal to the monthly interest expense will prevent capitalized interest from increasing the loan balance. Any additional money that you put toward the unsubsidized loans pays down the loan balances, which in turn reduces the next month's interest expense.

Whittling away at the unsubsidized loan balances reduces future interest expense. Since the government is picking up the tab on the subsidized loans' interest expense while you're in school, as well as during deferment or grace periods, you are better off paying down the loans where interest accrues.

When you pay down principal on either loan you save the interest expense you would have over the life of the loan. Since the subsidized loans' interest expense doesn't begin until after you leave school and the end of the grace period, you get more interest savings by paying down the unsubsidized loans now.

If you're not already using it, you can access your student loan data on the National Student Loan Data System (NSLDS). When you start making payments, review IRS Publication 970 to determine whether you can deduct the interest paid on your student loan. Finally, check out the benefits of consolidating your student loans after graduation by using the National Direct Student Loan Calculators.

-- Posted: Aug. 24, 2001

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