I was shocked when I saw the following tweet by Leslie from 27andFrugal fame:

twitter convo

It immediately caught my attention because amortization loans shouldn’t be paid forward like this, however, when I let Leslie know that was possibly making a mistake she didn’t believe me!  Despite not knowing Leslie I felt it my responsibility to help a girl out and make her a tad more efficient with her money.  After a few emails back and forth I learned that Leslie had a Student Loan:

  • Originally around $28,0000
  • 3.1%
  • 20 years Payments started 1/2004
  • She paid extra at some point but doesn’t entirely remember the details

What Leslie didn’t realize was that she could have saved hundreds if not more in interest over the life of the loan.

What is an Amortization Loan?

Before we attack Leslie’s specific situation we first need to understand what an amortized loan is and how extra payments should be applied.  An amortization loan is,

a loan with scheduled periodic payments of both principal and interest. This is opposed to loans with interest-only payment features, balloon payment features and even negatively amortizing payment features

When you make an extra payment to an amortization loan it is supposed to erase the last principal payments thus erasing the interest associated with those payments.  So lets look at an easy common example before coming back to Leslie’s specific situation.

  • $20,000 Car Purchase
  • 60 Month Pay Off
  • 5% Interest Rate

This leads us to the following amortization schedule:

As you can see we have 60 equal payments but the application of payments were different month to month (you may need to zoom in to see numbers).

What Happens to an Extra Payment to an Amortized Loan

If we add $50 to each payment we get the following results:

  • Saves 7 months of payments and
  • $352 in interest payments.

How? If you look at the Second half of the loan but applying an extra $50 each month

As you see some those $50 are erasing future payments.

Now lets get back to Leslie’s situation.

Adding an Extra Payment to Leslie’s Amortized Loan

It seems that at some point she was sending in her extra payments but her evil student loan company was applying the money to future payments and not on the back end to save Leslie money!  I even got screwed by a loan servicing company once too! Since I can’t fix the past I decided to look at the future, first a reminder about her situation:

Leslies Loan

Her goal was to pay her monthly payment and an $100 extra per month.

Before I update the post with my ultimate out of the box idea I want to hear what you would have told Leslie?