What Increases Your Total Loan Balance?

Are you wondering what increases your total loan balance? It’s not just the principal amount you borrowed. Factors like interest accrual, capitalization, fees, deferment, income-driven repayment plans, variable rates, and negative amortization can all cause your debt to grow over time.

In this article, we’ll dive into each of these concepts, explaining how they work and their impact on your total loan costs. We’ll also provide practical tips and strategies for managing your debt and reducing your loan balance effectively.

What is Total Loan Balance and How is It Calculated?

When you take out a loan, the total loan balance is the amount you owe back to the lender. It includes the original amount you borrowed, known as the principal, plus any interest and fees that accrue over time.

The initial loan balance is simply the principal amount. However, this balance can grow due to several factors. The most significant is interest, which is essentially the cost of borrowing money. Interest is typically expressed as a percentage of the principal and can be charged daily, monthly, or annually, depending on the loan terms.

For most loans, interest accrues on the unpaid principal balance. This means that each day, the interest charge is calculated based on your current loan balance. This accrued interest is then added to your balance, so you end up owing interest on the interest – a concept known as compounding.

In addition to interest, your loan balance can also increase due to fees. These might include origination fees, late payment fees, or insufficient funds fees, among others. When these fees are charged, they are added to your loan balance.

To calculate your total loan balance at any given time, start with your original principal balance, add any accrued interest that hasn’t been paid, and add any fees that have been charged. The resulting sum is your current loan balance.

Learn More:

• How Can You Reduce Your Total Loan Cost?
• is American Emergency Fund Legit?

8 Factors that Increase Your Total Loan Balance

1. Interest Accrual
2. Interest Capitalization
3. Fees and Penalties
4. Deferment, Forbearance, and Grace Periods
5. Your Repayment Plan
6. Variable Interest Rates
7. Negative Amortization
8. Making Minimum Payment

1. Interest Accrual

Interest accrual is one of the primary factors that can cause your total loan balance to grow over time. When you borrow money, the lender typically charges interest as a cost of providing the loan. This interest begins accruing as soon as the funds are disbursed, and it continues to accrue throughout the life of the loan until it’s paid off.

The amount of interest that accrues depends on your interest rate and loan balance. Most loans use a simple daily interest formula, which calculates interest based on your current loan balance each day. For example, if you have a $10,000 loan with a 5% annual interest rate, you’d accrue about $1.37 in interest each day ($10,000 x 5% / 365 days).

This daily interest accrual can really add up over time, especially if you’re not making payments or if your payments aren’t covering the full amount of interest due. In some cases, the accrued interest can be capitalized, meaning it’s added to your principal balance. From that point on, you’ll be charged interest on the interest, leading to compounding growth of your loan balance.

Interest accrual is especially important to understand with student loans. Many student loans, particularly unsubsidized federal loans and most private loans, start accruing interest as soon as they’re disbursed. If you don’t pay this interest while you’re in school or during your grace period, it can be capitalized, significantly increasing your loan balance before you even start making payments.

To minimize the impact of interest accrual on your loan balance, it’s best to make payments as soon as possible and to pay more than the minimum whenever you can. Even small additional payments can help reduce the amount of interest you pay over the life of the loan.

2. Interest Capitalization

Interest capitalization is a process where unpaid interest is added to the principal balance of a loan. This can cause your total loan balance to increase significantly over time, as you’ll start accruing interest on the unpaid interest.

Here’s how it typically works:

Let’s say you have a student loan with a $10,000 principal balance and a 5% interest rate. If you don’t make any payments while you’re in school, interest will still accrue on the loan. Let’s assume $500 in interest accrues over the course of a year. If this interest isn’t paid, it will be capitalized, meaning it will be added to your principal balance.

So, after a year, your new principal balance would be $10,500. From that point on, interest will be calculated based on this new, higher balance. If another $525 in interest accrues the following year and is capitalized, your principal balance would grow to $11,025.

Interest capitalization often occurs after periods of nonpayment or deferment, such as during the grace period after you graduate or if you temporarily pause your payments. It can also happen if you’re on an income-driven repayment plan and your monthly payments aren’t enough to cover the interest that accrues each month.

Capitalized interest can add a significant amount to your loan balance, especially if it happens multiple times over the life of your loan. To avoid interest capitalization, try to make payments on your accruing interest, even during periods of deferment or forbearance. Paying the interest as it accrues can prevent it from being added to your principal balance.

If you do end up with capitalized interest, remember that it’s now part of your principal balance, so you’ll want to focus on paying down your total loan balance as quickly as possible to minimize the amount of interest you pay over the life of the loan.

3. Fees and Penalties

Fees and penalties are another factor that can increase your total loan balance. When you take out a loan, it’s important to understand all the potential fees and penalties associated with the loan, as these can add significant costs if you’re not careful.

• One common fee is a loan origination fee. This is a charge assessed by the lender for processing a new loan application. Origination fees are often a percentage of the loan amount and they’re usually deducted from the loan proceeds before you receive them. While this fee doesn’t increase your loan balance directly, it does reduce the amount of money you receive from the loan.

• Late payment fees are another common penalty. If you miss a payment or pay after the due date, many lenders will charge a late fee. This fee is typically added to your loan balance, increasing the total amount you owe. Late payments can also trigger an increase in your interest rate, which can cause your balance to grow even faster.

• Some loans also come with prepayment penalties. These are fees charged if you pay off your loan early. While paying off your loan early can save you money in interest over the life of the loan, prepayment penalties can negate some of these savings.

For student loans, there are a few specific fees to be aware of. For example, federal student loans come with loan fees that are a percentage of the loan amount. These fees are deducted from each loan disbursement, so they don’t increase your loan balance directly, but they do reduce the amount of aid you receive.

Private student loans may also come with application fees, origination fees, or late payment fees. It’s important to carefully review the terms of any loan before you sign so you understand all the potential costs.

To minimize the impact of fees and penalties on your loan balance, always try to make your payments on time. If you’re struggling to make a payment, contact your lender immediately to discuss your options – they may be able to work with you to adjust your payment plan and avoid fees.

4. Deferment, Forbearance, and Grace Periods

Deferment, forbearance, and grace periods are all terms that describe periods when you’re not required to make payments on your student loans. While these periods can provide short-term relief if you’re struggling to make payments, they can also lead to an increase in your total loan balance.

• Grace period is a set period of time after you graduate, leave school, or drop below half-time enrollment when you’re not required to make payments on your student loans. Grace periods, which typically last six months, are designed to give you time to find a job and get financially settled before you start making loan payments.

• Deferment is a period during which you’re allowed to temporarily stop making payments or reduce your monthly payment. You may qualify for deferment if you’re enrolled in school at least half-time, if you’re in a graduate fellowship program, if you’re in a rehabilitation training program for the disabled, or if you’re unemployed or experiencing economic hardship.

• Forbearance is similar to deferment in that it allows you to temporarily stop or reduce your monthly payments. You may request forbearance if you’re experiencing financial difficulties, medical expenses, or other reasons that make it difficult for you to make your scheduled loan payments.

While deferment, forbearance, and grace periods can provide temporary financial relief, it’s important to understand that interest may still accrue on your loans during these times (with the exception of certain subsidized federal loans during deferment). If you don’t pay this interest as it accrues, it will be capitalized, meaning it will be added to your principal balance when the deferment, forbearance, or grace period ends.

This capitalized interest can significantly increase your total loan balance, making your monthly payments higher and extending the time it takes to pay off your loan. To avoid this, consider making interest-only or small payments during these periods, if possible. Even paying a small amount can help reduce the amount of interest that capitalizes.

Remember, while deferment, forbearance, and grace periods can be helpful tools if you’re facing financial challenges, they should be used sparingly. If you’re consistently struggling to make your loan payments, it may be worth exploring other options, like income-driven repayment plans or loan consolidation.

5. Your Repayment Plan

Your repayment plan can have a significant impact on your total loan balance over time. When you take out a loan, particularly a student loan, you often have several repayment plan options, each with its own terms, monthly payments, and total costs.

The standard repayment plan for federal student loans is a fixed monthly payment over a 10-year term. If you can afford these payments, the standard plan will generally result in the lowest total loan cost over time.

However, if your monthly payments under the standard plan are too high, you might consider an income-driven repayment (IDR) plan. These plans, such as Income-Based Repayment (IBR), Pay As You Earn (PAYE), or Revised Pay As You Earn (REPAYE), base your monthly payment on a percentage of your discretionary income and family size.

While IDR plans can make your monthly payments more manageable, they can also increase your total loan balance over time. Because your monthly payments may be lower than they would be under the standard plan, you may not be paying enough to cover the interest that accrues each month. When this happens, the unpaid interest is capitalized, meaning it’s added to your principal balance.

Moreover, IDR plans extend your repayment term to 20 or 25 years. While any remaining balance is forgiven at the end of this term, the extended timeline means more time for interest to accrue, potentially increasing your total loan costs.

Private student loans often have fewer repayment options, but some lenders offer graduated repayment plans where your monthly payments start low and increase over time, or extended repayment plans that lengthen your term to lower your monthly payments.

When choosing a repayment plan, it’s important to consider not just your monthly payment, but also the total cost of the loan over time. A lower monthly payment might be more manageable in the short term, but if it significantly increases your total loan costs, it might not be the best long-term choice.

Ultimately, the best way to minimize the growth of your total loan balance is to make the highest monthly payments you can afford. Paying more than the minimum whenever possible can help you pay off your loan faster and save money on interest over the life of the loan.

6. Variable Interest Rates

Variable interest rates can also cause your total loan balance to increase over time. Unlike a fixed interest rate, which stays the same for the life of the loan, a variable interest rate can fluctuate based on market conditions.

Most variable interest rates are tied to a specific index, such as the Prime Rate or the London Interbank Offered Rate (LIBOR). When these indexes go up or down, the interest rate on your loan will adjust accordingly.

For example, let’s say you have a private student loan with a variable interest rate that’s currently at 5%. If the index your rate is tied to goes up by a percentage point, your interest rate would increase to 6%. This higher rate would be applied to your outstanding loan balance, causing more interest to accrue and potentially increasing your monthly payment.

The unpredictability of variable interest rates can make budgeting for your loan payments more challenging. If rates rise significantly, your monthly payments could become unaffordable, leading to missed payments and additional fees.

Moreover, if your monthly payments don’t cover the interest that accrues each month due to a rate increase, the unpaid interest could be capitalized, meaning it’s added to your principal balance. This can cause your total loan balance to grow even faster.

However, it’s worth noting that variable interest rates can also work in your favor. If the index your rate is tied to goes down, your interest rate will decrease, potentially lowering your monthly payments and the total cost of your loan over time.

If you’re considering a loan with a variable interest rate, it’s important to understand how the rate is determined, how often it can adjust, and if there are any caps on how high it can go. You should also consider your ability to absorb potential rate increases and have a plan for how you’d manage your payments if rates were to rise significantly.

Ultimately, the predictability of a fixed interest rate can often be worth a slightly higher rate, especially if you’re on a tight budget or are risk-averse. However, if you’re comfortable with some level of risk and have the flexibility to absorb potential rate increases, a variable rate loan could save you money if rates trend downward over the life of your loan.

7. Negative Amortization

Negative amortization is a situation where your monthly loan payments are not enough to cover the interest accrued on your loan balance each month. When this happens, the unpaid interest is added to your principal balance, causing your total loan balance to increase over time, even though you’re making regular payments.

This concept is most commonly associated with certain types of mortgages, particularly adjustable-rate mortgages (ARMs). Some ARMs offer very low initial monthly payments, sometimes even less than the interest due each month. If the borrower makes only these minimum payments, their loan balance will gradually increase through negative amortization.

While less common, negative amortization can also occur with student loans, particularly if you’re on an income-driven repayment (IDR) plan. Under an IDR plan, your monthly payments are based on a percentage of your discretionary income, not on your loan balance or interest rate. If your monthly payment under the plan is less than the interest that accrues on your loan each month, your loan balance will grow through negative amortization.

It’s important to understand that negative amortization can significantly increase your total loan costs over time. As your loan balance grows, more interest accrues each month, which can lead to a cycle of increasing debt that can be difficult to overcome.

If you find yourself in a situation where negative amortization is occurring, it’s important to take action as soon as possible. This might mean making extra payments when you can to cover the unpaid interest, seeking a loan modification to adjust your repayment terms, or considering refinancing to a loan with terms that avoid negative amortization.

In the case of student loans, IDR plans that lead to negative amortization do offer loan forgiveness after 20-25 years of payments, which can provide a light at the end of the tunnel. However, any forgiven amount under these plans is currently treated as taxable income, so it’s important to plan for this potential tax liability.

8. Making Minimum Payment

Minimum payments are the lowest amount you’re required to pay on a loan or credit card each month to keep your account in good standing. While making the minimum payment can be tempting, especially if you’re on a tight budget, it’s important to understand how minimum payments can impact your total loan balance over time.

When you only make the minimum payment, a larger portion of your payment goes towards interest rather than your principal balance. This is because the minimum payment is typically calculated as a percentage of your balance or a small fixed amount, which is often not much more than the interest accrued that month.

As a result, making only the minimum payment can significantly extend the time it takes to pay off your debt and increase the total amount you pay in interest over the life of the loan. In some cases, if your minimum payment doesn’t cover the full amount of interest accrued that month, your loan balance can even increase through negative amortization, despite making regular payments.

Here’s an example: Let’s say you have a credit card with a $5,000 balance and an 18% annual interest rate. If your minimum payment is calculated as 2% of your balance, your first minimum payment would be around $100. However, the monthly interest on your balance would be around $75 ($5,000 x 18% / 12). So, out of your $100 payment, only $25 would go towards your actual balance, while $75 would go towards interest.

At this rate, it would take you over 30 years to pay off the $5,000 balance, and you would pay over $7,000 in total interest, more than the original balance itself.

To avoid the pitfalls of minimum payments, it’s always best to pay as much as you can afford each month. Even small additional payments can make a big difference in reducing your total loan costs and paying off your debt faster.

If you’re consistently struggling to make more than the minimum payment, it might be worth exploring other options, such as debt consolidation, balance transfer credit cards with introductory 0% APR periods, or adjusting your budget to free up more money for debt repayment.

Tips for Reducing Your Loan Balance

Here are some tips for reducing your loan balance:

• Make extra payments towards your principal: When you make a payment over the minimum amount due, the extra money is typically applied to future interest before principal. However, you can request that any extra payments be applied directly to your principal balance. This can help reduce your loan balance faster, which in turn reduces the amount of interest that accrues over the life of the loan.

• Use the debt avalanche method: If you have multiple loans, the debt avalanche method involves focusing your extra payments on the loan with the highest interest rate first, while making minimum payments on all others. Once the highest-rate loan is paid off, you move on to the next highest, and so on. This strategy can help you pay off your total debt faster and minimize the total interest you pay.

• Avoid deferment and forbearance when possible: While deferment and forbearance can provide temporary relief if you’re struggling to make your loan payments, they also allow your loan balance to grow through interest capitalization. If possible, try to avoid these options and instead look for ways to reduce expenses or increase your income to keep making payments.

• Make biweekly payments: Instead of making one monthly payment, consider splitting your payment in half and making biweekly payments. Over the course of a year, this equates to making one extra full payment, which can help reduce your loan balance faster without putting a major strain on your monthly budget.

• Consider loan forgiveness programs: For student loans, there are several loan forgiveness programs available, particularly for borrowers working in public service, education, or non-profit sectors. If you qualify, these programs can help reduce or eliminate a portion of your loan balance.

• Avoid taking on more debt: While this may seem obvious, it’s important to avoid taking on new debt while trying to pay down your existing loan balances. New debt increases your total balance and can make it harder to make progress on your repayment.

• Increase your income: Finally, increasing your income through a raise, promotion, side hustle, or job change can provide more money to put towards your loan balances. Even a small increase in your monthly payments can have a big impact over time.

Conclusion

Understanding the factors that can increase your total loan balance is essential for managing your debt effectively. Interest accrual, capitalization, fees, deferment, income-driven repayment plans, variable rates, negative amortization, and making only minimum payments can all contribute to your loan balance grows over time.

However, by being proactive and implementing strategies like making extra payments, using the debt avalanche method, avoiding deferment and forbearance when possible, making biweekly payments, considering loan forgiveness programs, avoiding new debt, and increasing your income, you can take control of your loans and work towards reducing your overall debt burden.

Remember, even small actions can make a big difference in the long run, so start implementing these tips today to put yourself on the path to financial freedom.

Frequently Asked Questions

You might like:

• 60monthloans Review
• Lendly Loan Reviews
• Grace Loan Advance Review