How can people make payments for 20 years on school loans and barely make a dent in the principal? How are those loans different than a mortgage?
In: Economics
Its normal to use 30-60% of your income towards housing (mortgage) not everyone has an extra couple thousand to put into school loans after their living expenses. Smaller payments = longer to pay, especially if the interest is high
The problem with loans in general is that if your payment isn’t greater than the interest charges each month, very little if any of your payment goes to the principal of the loan. If this is the case, the total loan balance won’t decrease over time.
Their isn’t anything intrinsically different. you have a principal a rate and period. Federal education loans do allow ‘income based repayment plans’ that if you are below a certain income, your eligible to pay less then the standard minimum monthly payments. In that case you could spend 20 years paying it and not make a dent.
Interest accumulates. If it outpaces your payments towards the principal then the loan balance increases.
People get into this problem with all kinds of loans. Even with credit cards. People think that the minimum payment is what they should pay. That’s just a made up number. There’s no promise that the minimum payment ends up killing your loan even over long periods of time. Usually only a small % of the minimum payment goes towards the principal. Most goes towards interest.
Bobby loans 1000 dollar at 3% interest.
The first year, bobby paid off 3 dollar per month, adding up to 3*12 =36 in the year.
Bobby has now paid 30 dollars in interest and only 6 to actually lower the loan.
There’s no collateral that can be repossessed if a student loan isn’t payed back, so it’s going to carry a higher interest rate.
If you don’t make big enough payments, the interest can build up faster than you’re paying it off.
People have the same issue with credit card debt: they make minimum payments and interest accrues faster than the debt can be payed off.
Nobody lets you cap your mortgage payment to less than the interest because you are making minimum wage/unemployed. You either make the minimum payment that will pay it off in the agreed time or they take the house.
The other difference between a mortgage and student loans is that mortgages are generally calculated for a fixed amount of time (usually 30 years). Assuming you have a fixed rate mortgage, this means that, based on the price of the house, you know exactly how much interest you will be paying. When you first start making mortgage payments, all of your payments go toward the interest, until the interest is paid off. Then your payments go toward the principle. You pay off the interest early. (Not all mortgages work this way, but this is typical)
But student loans you simply make payments until they are paid for. You don’t know how much interest you will ultimately pay, and the amount you pay each month might change. so you have to pay enough each payment to cover both the interest and some of the principle to make a dent.
User error, people dont check the interest rate and adjust their payment accordingly or make minimum payments. They are the same thing other than the school loan doesn’t have collateral (which is one of the many reasons they cost more), if you default on your mortgage they will take your house they’re out very little or they profit. If you stop paying your school loans they dont have anything to take and they are SOL.
If you don’t insure that your payments are larger than your interest rates your loan just increases and you give the bank money for no reason.
Student loans are very different from home loans. One type of student loan sets your payment as a fraction of your salary. The concept is that as you gain experience your salary increases, and eventually you’ll pay off the loan.
This doesn’t happen with home loans, because the house itself can depreciate if you don’t take good care of it. Student loans are secured by your knowledge, and that can’t depreciate. There are also laws that prohibit the discharge of student loans in bankruptcy, so the bank can hope to collect money from you forever. With a home loan, the bank can foreclose and sell the house, but there is no way to get the knowledge out of your head.
In general, student loans are a very sticky sort of thing, and the banks essentially want you to pay them forever. Alas, some students (and their parents) don’t really appreciate what they are agreeing to. People who are the first person in their family to go to college are, sadly, excellent candidates for the bank to take advantage of.
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