Student Loan Borrowers Who Prepay Suffer

NEW YORK (MainStreet) — Many borrowers strive to prepay their mortgages or car loans. Student loans can also be prepaid. But while mortgages and car loans are prepaid without problems, the prepayment of student loans turns the simple into the complex. The Consumer Financial Protection Bureau (CFPB) has received many complaints about the process.

Every year mortgages, car loans, and other consumer loans are prepaid by paying the current monthly payment due plus the principal of the next one or two months. Occasionally, a lump sum payment is made that will pay off several months or even a year's principal in advance. Normally there is no problem with this process. But in the area of student loans there seems to be.

The CFPB's Student Loan Ombudsman, Rohit Chopra addressed this issue in his October 16 blog entry. "Since many borrowers can't refinance, one of the only ways to avoid paying unnecessary interest is to pay their high-rate loans off more quickly," he wrote. "According to the Truth in Lending Act, your lender or servicer cannot assess any penalties or fees if you prepay your private student loan."

CFPB states that the policies of private student lenders and loan servicers are confusing borrowers who want to prepay their loans.

One problem is those with multiple loans with the same loan servicer - the company that does the monthly billing. Absent specific instructions, the servicer will allocate the payments to the excess of the amounts due.

"Leaving this decision up to them isn't always the best choice," the The CFPB advises. "Your student loan servicer should listen to your instructions about which loan your additional payment goes toward when you submit your payment."

But what CFPB does not state is that there are two problems with prepaying student loans.

One is what they describe. However, there is another. The prepayments are simply used to advance the next payment due date. They are not applied to reduce the principal. The advance is the default application of the payments.