When considering a loan, it’s important to understand the repayment terms—including details like how the principal and interest are paid over time. Doing so may help borrowers better manage their loans.
But there may be times when the total loan balance owed increases during the repayment process. While this may not be something a borrower expects, there are a few common factors that could explain a balance increase.
Read on to learn about the factors that can cause a total loan balance to increase and ways to decrease it.
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How to understand your loan balance
In many cases, the amount a borrower owes on an installment loan will end up being higher than the amount they borrowed. That’s because most lenders charge borrowers interest on top of their principal loan payment.
With that in mind, it can be helpful to understand some of the most common concepts that can affect the total cost of a loan. These may include the following:
- Principal amount: The amount of money originally borrowed.
- Interest rate: What the lender charges the borrower in exchange for access to funds.
- Annual percentage rate (APR): The total cost of borrowing, including interest, fees and other charges.
- Fees: Additional charges related to borrowing money, such as origination and payment processing fees.
- Loan balance: The amount of money the borrower still has to repay
Understanding these terms can come in handy when evaluating the factors that could increase a loan balance.
6 Factors That Increase Your Student Loan Balance
Here are a few reasons why your student loan balance might be going up, even if you’re making monthly payments:
1. Loan interest
Most student loans charge interest from the date your loan is disbursed. Student loan interest accrues daily based on your loan interest rate. Loans with higher interest rates will accumulate interest faster and come with higher monthly payments as a result.
Your loan payments are typically deferred until you graduate. That means you might not make student loan payments for four or more years. However, interest usually accumulates during this deferment period, so your loan balances will continue rising until you make payments.
For example, if you have $30,000 in student loans with a 7% interest rate, you could accumulate $2,100 in interest during your first year in school. This means your loan balance is now $32,100 after one year. If you don’t make any interest payments while pursuing your undergraduate degree, upon graduation, your $30,000 loan balance would be $38,400.
2. Unsubsidized vs. subsidized loans
Subsidized federal student loans do not charge interest while you’re in school or during the grace period after you graduate. The interest is paid by the government and does not accrue while your loans are deferred while attending school at least half-time.
Unsubsidized loans are federal student loans that accrue interest daily while you are in school. If you have unsubsidized loans, your balances will increase as interest accrues. Private student loans are similar to unsubsidized loans, and interest will accrue when the loan is dispersed.
3. Interest capitalization
Interest capitalization adds your accrued interest to your student loan balance. This usually occurs at the end of the grace period, typically after graduation.
If you have unsubsidized loans and don’t make any payments during school, the accumulated interest will be added to your principal loan balance. This means you will now pay interest on a larger balance, causing interest to accumulate even faster.
To avoid interest capitalization, you can choose to make interest payments while you’re in school or during any grace periods where interest is still accruing. This will prevent the interest from being added to your overall loan balance.
4. Student loan fees
In addition to interest charges, several fees may be assessed as part of your student loan application or repayment process, and these fees may be added to your loan balance.
Some common fees include:
- Loan origination fees. Most federal student loans include an origination fee equal to a small percentage of the total loan amount. Private loan fees vary and depend on the lender. For example, College Ave. does not charge an origination fee, but other private lenders do.
- Late payment fees. If you make a late payment, you incur a fee. Amounts vary by the type of loan and lender.
- Returned check fee. You may have to pay a fee if you pay your student loans by check and it bounces or is returned. This amount will also vary by lender.
- Non-sufficient funds (NSF) fees. If you make an electronic payment but don’t have the funds in your account, you may be charged an NSF fee.
- Collection fees. If your student loans end up in collections, you may be assessed fees for court costs, attorney fees, and other associated costs.
5. Income-driven repayment plans
If you’re on an income-driven repayment plan (IDR), you may end up with negative amortization. In this instance, your monthly payment is smaller than the interest charged on your loan, so interest accumulates over time. For some plans, the interest will be added to your total loan balance periodically increasing the amount you have to pay off.
As of July 1, 2023, students who elect the SAVE income-driven repayment plan no longer capitalize interest after leaving the plan. The only IDR plan that still capitalizes interest is the Income-Based Repayment (IBR) plan.
6. Deferment or forbearance
Most loans will accumulate interest if you defer your student loan payments (either while enrolled in school or for another reason). And entering a period of forbearance means you won’t make monthly payments, but interest will still accrue.
In both cases, interest will be added to your principal balance after restarting a regular payment plan, increasing your overall loan balance.
Common mistakes that lead to a higher loan balance
There are a few mistakes you can make when managing your student loan that will cause your loan balance to grow. Watch out for the following missteps:
Missed payments
If you miss a payment, you might be charged late payment fees. While these fees don’t typically affect your loan balance, they’ll be added to your monthly bill until you pay them off.
Not paying interest while in school
If you have an unsubsidized federal or private student loan, you can decide not to make any payments while in school. However, interest will accrue during that time and eventually capitalize, adding the accumulated interest to your loan balance. You can avoid this by repaying your student loan while in school.
Consolidating your loans
If you choose to consolidate your student loans, any unpaid interest will be added to your total loan balance on the new loan. This means your loan balance may be higher after loan consolidation than before, forcing you to pay interest on the higher balance.
Not applying for subsidized loans
If you qualify for subsidized federal student loans but don’t choose to use them, you’re missing an opportunity. Subsidized loans are designed to help those in financial need and don’t accumulate interest while in school or during any grace period.
3 factors that can make your payment go up
1. Variable or adjustable interest rate
Many debts have interest rates that can go up or down as financial markets change. Credit card issuers generally call these rates variable, while mortgage lenders call them adjustable. In both cases, the lender chooses an industry rate to watch (called an index). When the index moves up or down, your interest rate and payment may change according to the terms of the loan.
If the interest rate on your debt goes up, the total amount that you have to repay will be more than it would have been at the lower rate. The loan balance itself doesn’t go up, but the amount of money you have to spend to get rid of the debt does.
2. Penalty interest rates
Missing payments without a lender’s approval can be more costly than a formal forbearance or deferment. That’s because the lender may charge you a penalty interest rate. Penalty interest rates are a punishment for paying late or violating the terms of your loan (if your payment is returned for insufficient funds, for example). Penalty interest rates are higher than your regular rate, which increases what you have to pay. Technically, higher interest increases your cost but not your loan balance.
3. Taxes and insurance
Sometimes, your mortgage payment includes an amount for property taxes and homeowners insurance. Your lender collects this from you each month and then pays those bills when they come due. This is called escrow or impounding. If your mortgage has impounds, your payment will increase if those costs go up. Higher taxes or insurance costs don’t make your loan balance increase, but they do increase what you have to pay.
How can you reduce your total loan cost?
Several factors can cause the total balance of a loan to increase. But there may be ways to reduce the overall cost of a loan, too. Consider the following ways to potentially reduce the total cost of a loan:
- Making extra payments: Making an additional payment or two on a loan balance can help borrowers reduce the amount owed more quickly. By making an extra payment, the borrower pays down the remaining loan balance—and could lower the amount of interest owed on their next payment.
- Paying more than the minimum: Similarly, putting extra money toward a loan each month may help borrowers pay off their debt faster and save on interest.
- Automating your payments: Some lenders may offer discounts when borrowers set up automated payments on loans.
- Applying for loan forgiveness: With some loans—such as student loans—qualifying borrowers can have some or all of their loans forgiven. If that’s the case, they may have to pay back less than they borrowed.
And if none of these options are suitable, borrowers could consider refinancing their loan. Refinancing can potentially allow borrowers to get better interest rates or repayment terms by replacing their existing debts with a new loan. Refinancing could also give borrowers an opportunity to shop around and compare loan offers.
But keep in mind that refinancing terms are often based on factors like payment history and credit scores. So it may be a good idea to consider ways to strengthen your credit scores before beginning the refinancing process.
FAQ about Loan Balances and Repayment
1. Why does my loan balance increase over time?
Loan balances typically increase due to accrued interest, fees, interest capitalization, and periods of deferment or forbearance where interest continues to accrue.
2. What is interest capitalization?
Interest capitalization occurs when unpaid interest is added to the principal balance of a loan. This increases the total amount you owe, and interest subsequently accrues on the new, higher balance.
3. How can I avoid interest capitalization?
To avoid interest capitalization, consider making interest payments while in school or during grace periods. This prevents unpaid interest from being added to your principal loan balance.
4. What are common fees associated with loans?
Common fees include loan origination fees, late payment fees, returned check fees, NSF fees, and collection fees. These fees can add to your loan balance if not paid promptly.
5. How can income-driven repayment plans affect my loan balance?
Income-driven repayment plans may result in negative amortization, where monthly payments are less than the accrued interest. This can lead to an increase in the loan balance as unpaid interest is capitalized.
Conclusion
Understanding the factors that contribute to an increasing loan balance is crucial for borrowers to effectively manage their debt. Accrued interest, fees, and the terms of repayment plans can significantly impact how much you ultimately pay back on a loan. It’s important to be proactive in managing your loan by making timely payments, understanding the terms of your loans, and exploring options to reduce costs where possible.