How to Use Your Tax Return Effectively to Reduce Student Loan Payments

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Considering paying off your student loan debt with your tax return or just a lump sum of money? There can be more to larger payments than meets the eye. Follow these steps to learn how to make the most of your payment.

1. Make a List

Knowing which loans you want to pay off first will help you get the most bang for your buck. Make a list of all of your federal and private student loans, the balances, and the interest rates. Then, based on your goals, weigh your options. You could put your lump sum payment toward your highest interest rate loans, or pay off your low-balance loans first. Paying off your highest interest rate loans would reduce the amount of interest you’ll pay and save you money over the life of the loan, while paying off your lowest balance loans first could save you money on your monthly payment. Paying off your lower-balance loans would allow you to put the money saved from a lower payment toward your other student loans, helping you to pay them off faster.

2. Talk to Your Loan Servicer

Check to make sure your loan servicer knows how you want your payments applied to your student loans. If you pay above the minimum payment and don’t specify which loan or how you want the excess dollars to be applied, your loan servicer will most likely decide for you.

Below is a sample letter put together by the Consumer Financial Protection Bureau (CFPB) that you can send to your loan servicer to ensure payments above your minimum monthly payment amount are being applied to the correct loan(s). For some servicers, this can be done online.

I am writing to provide you instructions on how to apply payments when I send an amount greater than the minimum amount due. Please apply payments as follows:

  1. After applying the minimum amount due for each loan, any additional amount should be applied to the loan that is accruing the highest interest rate.
  2. If there are multiple loans with the same interest rate, please apply the additional amount to the loan with the lowest outstanding principal balance.
  3. If any additional amount above the minimum amount due ends up paying off an individual loan, please then apply any remaining part of my payment to the loan with the next highest interest rate.

It is possible that I may find an option to refinance my loans to a lower rate with another lender. If this lender or any third party makes payments to my account on my behalf, you should use the instructions outlined above.

Retain these instructions. Please apply these instructions to all future overpayments. Please confirm that these payments will be processed as specified or please provide an explanation as to why you are unable to follow these instructions.

3. Things to Keep In Mind

There are a few other things to be mindful of once you’ve decided where to apply your lump sum payment.

  1. Follow up with your loan servicer by calling or checking your accounts online to make sure your payment was applied as specified.
  2. Making a payment larger than your minimum payment amount can sometimes advance your due date, meaning another payment on your student loans won’t be due until your minimum payments catch up to your lump sum payment. While it can be nice to skip a few months of student loan payments, your loans will still accrue interest and won’t save you any money. Even if your due date advances, continue to make your monthly payments to save yourself money in the long run.
  3. You can also save money on your student loans by refinancing. Refinancing allows you to combine both your federal and private student loans into a new loan with a new repayment term and interest rate, which can often save money over the life of the loan, or help lower your monthly payment.

Paying off your student loans is a great accomplishment. As you begin to make decisions around your personal finances, make sure to keep these tips in mind so that you can make the best choices for your financial future.

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