what increases your total loan balance

How Interest Contributes to Loan Balance 

The interest rate on a loan determines how quickly the total balance grows over time. There are two main types of interest that impact increases your total loan balance:

Simple Interest

With simple interest loans, the interest is calculated only on the original principal amount. If you borrowed $10,000 at 5% simple interest, you would owe $500 in interest per year ($10,000 x 0.05). Your total loan balance after one year would be $10,500.  

The interest charge stays the same each year, so your balance grows linearly. After two years at 5% simple interest, your $10,000 loan would have a balance of $11,000. The interest owed each year is always based on the original principal.

Compound Interest 

Most loans use compound interest, which means interest accrues on both the principal and accumulated interest. With compound interest, your loan balance grows exponentially. 

Using the same example, a $10,000 loan at 5% compound interest would have a balance of $10,500 after one year. However, in the second year, the 5% interest would apply to the $10,500 balance, so you would owe $525 in interest. After two years, your total balance would be $11,025.

Over time, the compounding effect leads to substantially higher loan balances. This is why making early extra payments to pay down principal can save money in the long run.

Capitalization of Interest

Capitalized interest occurs when accrued interest on a loan is added to the original principal balance. This increases the total loan amount that you owe. 

Interest capitalization happens in certain situations:

  • If you have an unsubsidized loan and choose not to pay the interest as it accrues during in-school and grace periods. The unpaid interest gets added to your principal balance when the grace period ends.
  • If you postpone payments through deferment or forbearance. The interest that accrues during the deferment/forbearance period gets capitalized at the end. 
  • If you change repayment plans. Unpaid interest capitalizes when you switch plans.
  • If you default on your loan. The entire amount of unpaid interest gets added to the principal when your loan defaults.
  • If you consolidate loans. Unpaid interest on the loans being consolidated gets added to the balance of the new consolidation loan.

The more interest that gets capitalized, the more your loan balance grows. This results in paying more interest over the life of the loan. To avoid capitalization, pay interest as it accrues during school, grace periods and deferments. Also, make payments if possible during forbearance. Limiting capitalization can save money in the long run.

Late Fees

Late fees and penalties for missed payments can quickly increase your student loan balances. If you miss a monthly payment, most student loan servicers will charge a late fee, usually around 5% of your monthly payment amount. So if you miss a $300 payment, you may be charged a $15 late fee. 

While that $15 seems small, it gets tacked onto your overall loan balance. So not only do you still owe that original $300 you missed, now your balance is $315 higher than before. If you miss multiple payments in a row, those late fees really start to add up. Some private student loans will even charge very high late fees, like 25% of the missed payment.

Late fees also often trigger penalty interest rates on federal student loans. If you are over 60 days late on payments, your interest rate can jump to a much higher penalty rate. On direct loans, the penalty rate is an extra 6.8% above the normal rate. So if your rate was 5%, it would shoot up to 11.8% once you’ve missed 2 monthly payments. This substantially increases the interest you accrue each month.

The bottom line is that every late payment comes with financial consequences beyond just owing that month’s amount. Late fees directly raise your balance, and penalty rates indirectly raise your balance by charging you higher interest. Avoiding late payments is crucial to keeping your total student loan burden as low as possible. Look into options like auto-debit payments and student loan rehabilitation if you are struggling to make monthly payments on time.

Deferment or Forbearance

One of the main ways your total loan balance can grow is if you postpone making payments through deferment or forbearance. With federal student loans, you have the option to temporarily pause your payments through deferment or forbearance if you meet certain eligibility criteria. 

Deferment allows you to temporarily stop making payments for reasons such as being enrolled in school at least half-time, unemployment, economic hardship, or active military duty. Interest typically does not accrue on subsidized federal loans during deferment, but it does continue to accrue on unsubsidized loans.

Forbearance allows you to temporarily reduce or postpone your payments for up to 12 months at a time if you are experiencing financial hardship. The key difference with forbearance is that interest continues to accrue on both subsidized and unsubsidized federal loans. 

If you use deferment or forbearance, you are not required to make payments during that period. However, the interest that accrues will be capitalized (added to your principal balance) when you resume making payments. This increases your total loan balance and the amount of interest you end up paying over the life of the loan.

Therefore, it’s important to weigh the pros and cons before pursuing deferment or forbearance. While it provides short-term payment relief, postponing payments too frequently or for too long can substantially increase your overall debt. Try to make at least the interest payments if possible during deferment/forbearance to avoid balance growth.

Loan Consolidation

Consolidating multiple student loans into one new loan can increase your total loan balance over time. When you consolidate loans, it essentially creates a new single loan that pays off all your existing loans. This new consolidation loan will have a fixed interest rate based on the weighted average of your previous loans’ rates.

While consolidation can provide some benefits like simplifying repayment to one monthly bill and potentially lowering your monthly payment amount, it also extends your repayment term. Most federal consolidation loans allow repayment periods of 10-30 years depending on your total debt amount. Private lenders may offer even longer terms. 

Extending your repayment duration means you’ll be accruing interest over a longer timeframe. This increased interest accumulation results in paying more in total over the life of the loan. Consolidation also eliminates the option to target extra payments to loans with higher interest rates. 

For example, if you had $30,000 in student loans at 6% interest and 10 years left to pay them off, consolidating into a new 20-year term loan at 5% interest would lower your monthly payments but increase your total repayment to over $52,000. Without consolidating, your total repayment would have been under $46,000.

So while consolidation can provide some advantages, it’s important to consider the tradeoffs of higher long-term costs and interest paid when determining if it aligns with your financial goals. Analyze your options thoroughly and run the numbers to see if consolidation makes sense for your situation.

Lack of Extra Payments

Not making extra payments on your loans causes them to take longer to pay off and accrue more interest over time. When you take out a loan, the lender calculates a minimum monthly payment amount that allows you to pay off the loan over the full repayment term, often 10-25 years for student loans. This minimum payment only covers the monthly interest plus a small amount of principal. 

By only making the minimum payment each month, the bulk of the original principal balance remains unpaid for years. All the while, interest continues accruing on the outstanding principal amount. This means you end up paying interest on interest, called compound interest. The interest builds up exponentially over the life of the loan under this payment structure.

Paying extra each month speeds up the repayment. Even an extra $20 or $50 per month makes a difference. The extra money goes directly toward the principal, helping to pay down the balance faster. This reduces the total interest you pay over time. The less principal remaining, the less interest accrues each month. Paying a little extra in the beginning of repayment has an outsized impact thanks to the power of compound interest working in your favor.

Setting up automated payments of any amount over the minimum can greatly reduce loan balances. Creating a budget that allocates bonus income like tax refunds or work bonuses toward extra loan payments accelerates repayment as well. Evaluating expenditures to find areas to trim in order to pay extra is another smart strategy. The higher the loan balance and interest rate, the more vital it is to pay above the minimum when possible.

Co-Signing Private Loans

Taking out private student loans often requires a creditworthy co-signer. Federal student loans do not require a co-signer, but private student loans typically do since undergraduates and graduate students often have little income or credit history. Parents, grandparents, aunts/uncles, and sometimes friends or significant others with good credit may agree to co-sign a private student loan. 

The co-signer takes on equal responsibility for repaying the loan. The loan will appear on both the primary borrower’s and co-signer’s credit reports. If the primary borrower misses payments or defaults, it damages both their credit. The lender can pursue collection from either party. 

Some private lenders may release a co-signer after the primary borrower makes a certain number of on-time payments. However, the co-signer is liable for the life of the loan unless formally released. Taking on a co-signer obligation allows the primary borrower to access additional funds, but puts the co-signer on the hook for balances that keep growing with interest over an extended repayment term.

Variable Interest Rates

Variable interest rates on loans can lead to rising loan balances when market rates increase. With a variable-rate loan, the interest rate fluctuates based on an index like the prime rate. This means the rate can go up or down over the life of the loan.

When interest rates in the broader economy rise, variable-rate loans will see their rates increase as well. For example, if the prime rate goes from 3% to 5%, a variable rate loan tied to prime will also rise by 2 percentage points. 

This rate increase leads to higher interest charges each month since the interest is calculated as a percentage of the outstanding principal balance. With a higher interest rate, more interest accumulates. This increased interest gets added to the overall balance through capitalization if it’s not paid off.

For example, if you have a $10,000 student loan at 5% interest, about $42 in interest accrues each month. If the rate rises to 7%, the monthly interest jumps to $58. That’s $16 more in interest each month that gets added to the balance when capitalized.

Over time, even small increases in interest rates can snowball into large balance increases, especially on long-term loans. This makes budgeting difficult since the required monthly loan payment will also rise with the interest rate.

To avoid escalating balances, those with variable-rate loans need to try to pay down the principal fast when rates are low. That way, fewer principals is subject to higher rates when they eventually increase. Making extra payments and avoiding capitalization of interest is key. Consolidating or refinancing to a fixed-rate loan can also shield borrowers when rates rise.

Credit Card Debt

Carrying credit card balances can significantly impact your ability to pay down student loans. Credit cards often have much higher interest rates compared to federal student loans, with averages around 15-20% or even higher. 

If you’re making minimum payments on credit cards while trying to tackle student loans, more and more of your monthly payments is going towards interest versus principal on your credit cards. This means your balances are not dropping as fast as they could be if paid off in full each month.

The end result is you have less money overall each month to put towards your student loans since so much is being siphoned off to credit card interest. Those high rates can quickly snowball your total debt burden.

It’s crucial to pay off credit cards in full each month. If that’s not possible due to large balances, consider consolidating credit card debt to a lower-interest personal loan. This can provide monthly savings to redirect towards student loans. Limit use of credit cards until your overall debt is reduced.

Carrying credit card balances makes it very hard to get ahead on student loan payments. The debt will continue to grow from the high-interest charges. Get credit card debt under control first before making extra student loan payments. This will maximize the amount that goes towards actually reducing your principal loan balance each month.

Seeking Help to Reduce Balances

There are many ways to seek help and reduce your total loan balances. Here are some tips:

Refinance your loans – Consider refinancing your federal or private student loans to a lower interest rate. This can reduce the total amount you pay over the life of the loan. Make sure to shop around and compare rates.

Switch repayment plans – If you have federal loans, you may qualify for an income-driven repayment plan like PAYE or REPAYE. These cap payments at a percentage of your income and extend repayment terms, which can result in lower monthly payments. The remaining balance is forgiven after 20-25 years.

Apply for forgiveness programs – Research loan forgiveness programs like Public Service Loan Forgiveness or Teacher Loan Forgiveness. If you qualify, you may be able to get part or all of your federal loans forgiven after meeting program requirements. 

Make extra payments – Even small extra payments made when you’re able can make a big difference in your total interest costs and help pay down the principal faster. Set up automatic payments for any extra each month.

Look into employer repayment assistance – Some employers offer student loan repayment benefits. See if yours offers any programs to help tackle your debt.

Consolidate credit card debt – If you use credit cards to pay for school, consider consolidating that debt through a personal loan or balance transfer card with a lower interest rate. This can save on interest charges.

Get free expert advice – Nonprofit organizations like the Institute of Student Loan Advisors offer free consultations with experts who can review your full financial situation and suggest tailored repayment strategies.

The key is to explore all options that can reduce your monthly payments, interest costs, or principal balance. Every bit helps lessen the burden of student loans over time. Don’t hesitate to seek out assistance.

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