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Apply As Refund Or Apply As Payment? (Explained & Solved!)

Jamey Muller
Updated: July 6, 2022
5 min read

When you attempt to pay down a loan within a few months of receiving the funds, your lender will ask you if you want to apply for the money as a refund or as payment.

Which is the better option between the two? This article will help you decide.

Here’s What Apply as Refund and Apply as Payment Means:

Apply as refund” means the money you paid to your lender will be directly reduced from the principal balance you owe. Meanwhile, apply as payment is treated as regular payment, applied first to any accrued interest, then to your principal. Both options are given if you opt for early settlement.

Early payment is when you attempt to pay down within 120 days of loan disbursement. 

For example, you want to pay back $500 to your lender after receiving $10,000 for your new loan. When you apply, you will be asked how you want that $500 to be used.

If you “apply as refund,” your payment will go solely to the principal or the amount you originally owe, less any interests or finance charges.

This is treated as a loan cancellation payment; effective immediately, on the same date, the loan was disbursed.

With a refund, any origination fee you were evaluated will be adjusted based on the new, reduced principal balance. This means that any accrued interest will also be recalculated.

If you apply as payment, the money will be used primarily to pay any accumulated interest, then eventually, your principal balance.

While it is not a required payment, paying down a loan within a few months after receiving the funds can help you in the long run. 

You need to apply for payment within four months of when the money was disbursed. If you are already at the repayment status, this will no longer be your concern.

apply-as-refund-or-payment_couple-having-debt-problems

What Method Should You Choose?

The “apply as refund” method will ultimately save you the most money between the two options.

When you use the payment as a refund, it will result in a smaller principal balance since the money will be deducted from the original amount in your loan.

A principal is the base amount you owe for the loan. 

With a refund, the accrued interest in your loan will also be lessened. Interest rates typically vary depending on the type of loan you have. 

For instance, your original loan is $10,000, and you want to pay $500. When you choose to refund, your loan balance will be reduced to $9,500 upon receipt of your $500 early payment. 

The interest will then be revised downward to reflect the new $9,500 balance instead of the initial amount of $10,000.

If you apply for payment, your loan balance will remain at $10,000. The $500 will be applied to the interest. Once the interest has been wholly paid off, any excess will be deducted from the principal balance.

Early payments are always beneficial, but if you have to choose a route where you can save a lot more money, applying for a refund is the superior option.

Advantages of the “Apply as Refund” Method:

In most loans, payments within 120 days after disbursing of loan money are generally treated as refunds.

Refunds are essentially returning some of the money in your loan. Since they are directly applied to the amount you initially borrowed, they reduce the loan’s actual cost.

More importantly, borrowers get to save money from the decreased overall accrued interest with refunds.

Once they are applied, lenders will have to accurately recalculate any current dividends to reflect the lower principal balance.

This lets you avoid years of accrued interests on the portion of the loan.

The risk of choosing longer repayment terms on loans accumulates more interest charges over time.

Most borrowers choose longer loan terms and stretch out payments for several years, encouraged by the lower monthly payments.

In reality, this type of term makes your loan all the more expensive. It all boils down to how much more interest you have to pay in the succeeding years.

Interest rates are also primarily based on the length of your loan. Higher interests are applied for longer loan terms due to lender risks.

Soon after the money has been received, a refund will go a long way in reducing the original principal and the interest collected over time.

Advantages of the “Apply as Payment” Method:

By selecting the “apply as payment” method, your early payment will be applied first to any accrued interest in your loan.

This helps you keep up with your dividends so they are not capitalized.

Capitalized interests are accumulated by unpaid interests added to your principal, increasing the total amount of your debt.

They may also lead to compound interest, where interest is charged on your capitalized interest.

Capitalizing accrued interest is expected for student loans in deferment, where borrowers postpone repayment until they graduate.

While in school, you are not required to make payments. However, the interest is accruing from the day you received the loan money.

During this time, your interest is just simple interest, meaning it is only based on your principal balance. It is also not compounding since you are not paying interest on interest.

Once you leave school and the grace period elapses, you enter the repayment status and start making payments.

At this point, all the accumulated interest is capitalized. This necessitates that the interest will be added to your loan principal. The interest will now be computed on the new, larger amount when this happens.

You can avoid this by applying for early payment. You can pay the interest before it becomes capitalized, saving you from shelling out on more interest later.

Not all student borrowers can do this, but you definitely should take that path if you can.

This only applies if you pay within 120 days, just like the refund option.

With “apply as payment”, you will not benefit from the reduced principal loan balance that the refunds offer.

Sources:

Saving for College: Do Student Loans Have Prepayment Penalties?
Cappex: How to Prepay a Student Loan
Investopedia: What does it mean to capitalize accrued interest?

Written by
Jamey Muller
I'm the head-writer @ Knowledge Eager (or, in plain English, I'm the guy writing the majority of the content here). Addicted to the stock market, football, sushi and tacos.
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Jamey Muller
I'm the head-writer @ Knowledge Eager (or, in plain English, I'm the guy writing the majority of the content here). Addicted to the stock market, football, sushi and tacos.