‘Student loans are a real relief!’ – said no one ever. How could anyone be so dishonest, after all! Right now, the U.S has a 1.6 trillion student loan crisis.
The figure itself states how tricky the loan’s nature is. When it comes to student loans, increasing loan balances seems a frustrating yet inevitable issue. Many borrowers complain that their loan balances are much higher than they borrowed.
According to recent statistics, around 50% of all student loan borrowers face the issue of increased loan balance after five years. While in a few cases, late fees and missed payments work as the explanation for the larger balances, in many cases, the borrower doesn’t do anything wrong but still ends up having a bloated loan balance.
Keep rolling your eyes through this post if you are doubtful about what increases your total loan balance. It clears the air by helping you understand terms related to your student loan.
What Is Interest?
Interests refer to the monetary charge that every borrower is bound to pay for the privilege of accessing money when they are in need. The concept of interest came into the picture during the renaissance.
Before that, the social norms of ancient and medieval civilizations used to see the practice of applying interest as a sin because only people in bad need used to borrow money. Besides, at that time, there was no other product except for money considered as loaning assets.
However, this moral dubiousness started disappearing during the renaissance. The practice of borrowing money crossed the boundaries of fulfilling daily needs. People began to seek financial helps for business expansion and to improve their financial condition.
This made loans more mainstream and created a channel of earning for the lenders. Money gradually became a commodity, and the opportunity cost of borrowing it started to be considered a justified charge. Presently, interest is expressed as APR or Annual Percentage Rate. You can categorize interests into two different types – simple and compound.
Simple Interest
Simple interest is a quick and convenient method of calculating the applied interest rates on any loan. To determine simple interest, you can multiply the daily interest rate by the principal and the number of days between payments. Any short terms loans, vehicle loans, a few mortgages, etc., charge interest using this calculation.
The simple interest formula perfectly justifies its namesake – Simple Interest = P x I x N (P= Principal, I = Daily interest rate, and N = the number of days between the payments). As simple interest is calculated daily, it notably benefits loan consumers. Suppose you have obtained a student loan to pay one year of college tuition, which costs you $20,000; the APR is 5%. You will have to pay off the loan in the next three years.
So, the amount of simple interest will look like: $20,000 x .05 x 3 = $3000. Therefore, the total payable amount is $20,000 + $3000 = $23,000. When you pay early every month, simple interest helps shrink your principal balance faster. As a result, you can pay off your debt before the estimated time arrives.
On the other hand, when you delay your payments, you pay more towards your interest than the principal. Your final payment turns larger than your original estimation. This occurs when you fail to pay off the principal within a stipulated timeline (because you are not paying the principal at the expected rate).
Compound Interest
Compound interest refers to the interest that the lender implies on both principal and the interest. You can explain compound interest with the help of basic school-level mathematics.
For example, you borrowed $100, which has an APR of 5%. At the end of the year, you will have to pay a total of $105. At the end of the second year, you will have to pay $100.25. This will add up over time till you close your loan completely.
Whether your loan is subsidized or unsubsidized determines your responsibility for paying off interest accruing. When you avoid paying the interest on an unsubsidized loan, your lender may choose to capitalize the amount.
What Is Capitalization?
Capitalization refers to the addition of unpaid interest to the principal loan balance. The principal loan balance typically increases when the loan payments are postponed or unpaid.
Typically, you don’t need to pay anything towards your student loan when you are enrolled in school at least half or six months after your leave. However, this applies to subsidized loans only. When you have unsubsidized federal loans, you will still have to experience accrued interest during the said periods.
Once you start repaying your debts, this accrued interest will capitalize. As a result, your new loan balance will bloat like a balloon. Depending on your repayment plan, capitalization may notably increase your monthly payment.
What Makes Loan Balance Ascend?
There are several factors contributing to an ascended loan balance. Naturally, you will always want to pay as little interest as possible as a borrower. However, if you put yourself in your lender’s shoes, you can see the other side of the coin. Interest is the primary channel of income for lenders.
Besides, lending is never risk-free. When someone takes the risk, asking for a cost is justified. Therefore, the responsibility of playing tricky is always on the borrower’s shoulders.
Following are some of the most common factors contributing to an increased loan balance. Knowing about them can help you prevent your loan balance from growing.
Delaying In Repayment
Lenders typically don’t ask you for immediate repayments when you borrow money. They expect the amount on time, though. However, for several reasons, you may delay the payment.
Besides, certain delays depend on the purpose and type of the loan. For example, most students can’t repay their loans regularly until they complete their studies. However, the capitalization keeps working in the background, which increases the loan amount in this period. Naturally, this significantly raises the loan balance.
Make Lesser Payment Than The Requested Amount
Your loan balance can significantly increase when you pay less than your lender requests. Often, private lenders let you pay a temporarily reduced amount. Though it may look like a lucrative break for many, the reality is that the interest is still accumulating. Naturally, this allows lenders to earn a few extra bucks; however, as a borrower, you experience an increased loan balance in the long run.
Income-Driven Payments
This issue typically happens with federal student loans. Federal income-driven plans allow let borrowers to make payments based on their income. This repayment structure doesn’t depend on what the borrower owes. Though it may sound pretty relaxing, it may actually increase the monthly interest on the loan, and when it happens, the entire loan balance starts rising over time.
Extended Repayment
When you take a loan, you can find plans that allow you as long as 20 years to pay the amount in full. You may definitely be happy about those long tenures; however, the reality differs.
The payments you make in the early days go towards the interest. As a result, this makes the process of paying down the principal amount utterly slow.
Adding up this amount with the accumulated interest you have grown during school makes a bulky loan balance, which is way larger than the original borrowing amount.
Forbearance And Deferments
There are a lot of lenders who let their struggling borrowers take a break from consistent payments. For student loans, you can even expect certain grace periods. However, the interest still counts, increasing the total loan balance in the long run.
Errors In Calculation
To err is human, and lenders are not aliens! Even they can make mistakes which can bring bitter results like raised loan balance. While making manual adjustments to the balance, your lender may make a few wrong calculations.
Due to this reason, you should always keep copies of loan statements and documents so that you can produce them as proof to claim that your lender has made awful mistakes. You can file a complaint with the Consumer Finacial Protection Bureau (CFPB) to get those deadly errors corrected.
How To Lower Your Loan Balance Gradually?
There are several manageable ways to reduce your loan balance. Besides, by following these tricks, you can pay off your student loan much more efficiently, making way to make the most of each payment.
Pay More Than the Minimum Payment
Try paying a few bucks extra every month. When you spend some extra money with your monthly loan payment, you can significantly reduce the total cost of your loan over time. You can keep paying the monthly payables even if you have already satisfied your future payments.
This will help you pay off your loan faster. However, before making additional payments, confirm with your lender if those payments can be allocated to your higher-interest loans.
Opt-in Automatic Debit
Signing up for auto-debit can reduce your interest rate by 0.25%. Typically, almost every lender lets you opt-in for automatic deduction of your student loan payment. All you need is to update your details with your lender and give your consent for automatic deductions.
Setting up auto-deductions will help you make timely payments. Besides, you will get the said 0.25% interest rate deduction for enrolling. Before signing up for auto deduction, check whether your loan is eligible for the interest rate reduction or not.
Avoid Delayed Payments
It’s worth remembering that interest rates occur when you delay payments or pay lower than the amount requested. Therefore, start paying off your student loan payments during the grace period itself. You can even pay them off when you are in school.
Though you are not bound to pay in the suggested way, doing so will help you cover the monthly accrued interest. This will result in lesser interest capitalization. In this way, you will be able to reduce your principal loan balance.
Pay Loans with Tax Refunds
One of the most convenient ways to pay off your loan faster is dedicating your tax return to paying off your student loan debts. Student loan interests are tax exempted, and due to this reason, you receive tax refunds. So, it won’t trouble you to dedicate that amount to pay that interest.
Loan Forgiveness/ Repayment Alternatives
You can apply for a federal student loan forgiveness program in a few situations. Different forgiveness and repayment programs are available for public servants, teachers, army personnel, etc. However, these programs typically feature certain eligibility requirements.
Consider checking out your qualifying status before you apply for forgiveness. Apart from forgiveness, you can also check with your employer to find out if they offer repayment assistance for student loans.
Try Out Snowballing
If you have considered paying more than the minimum amount, you can also try the debt snowball method. It asks you to make the minimum payment on all your debts. The smallest ones, however, are exceptions. You can pay those small payments as much as you can.
This way, you can snowball payments towards your smallest debts. This will allow you to pay it off quickly and move on to the next smallest loan amount. The method can effectively help you to focus on a single debt at a time. This way, you minimize the chances of missing payments because of financial strains.
Typically, the snowball method works well for any loan, including student loans, mortgage loans, vehicle loans, etc. However, you shouldn’t use this method to pay off payday loans as they feature much higher interest rates. Thus, you should pay them off at the earliest.
Crosscheck Your Budget
Though it’s not directly related to the loan balance reduction, it can help you save some bucks on your loan payment. When you earn more and spend less, you can pay your debts more quickly by adjusting your budget.
You can pay extra with your monthly payments, snowball easily, and most importantly, always keep some money in hand to pay your interest on time. All of this together helps pull down your total loan balance. Therefore, take out a little time to cross-examine your budget. Remove the unnecessary expenses and classify items as needs and want.
Refinancing
You can also consider refinancing your debt to a lower interest rate. This can help you save a lot of bucks in interest. Besides, you can pay off your loan faster. You can use a debt consolidation program to refinance your student, personal, vehicle, or mortgage loans. You can even transfer the debt to a balance transfer card featuring 0% APR for a particular time.
Loan Avalanche
The debt avalanche strategy works almost like the snowball one. However, it focuses on ordering debts by interest rate. This works the best when you have more than one loan to pay off. To apply debt avalanche, first, you need to list all your loans. Arrange them in the order which keeps the interest debt first and then the lowest ones.
Once done, you can start paying off the loans with higher interest rates fast and make minimum payments on every other debt. This helps you cut back on the total amount you pay towards interest. In addition, by making on-time payments, you help lower the total loan balance.
Understanding The Basics Of Student Loans
Now that you know about repayments and how to reduce the total loan balance, here’s a quick revision of the subject. Understanding the nitty-gritty of a student loan may help you plan things better, allowing you to avoid the chances of increasing the loan balance outrageously.
What Does a Student Loan Refer To?
The straightforward definition of a student loan looks like this – when you borrow money from the government or any private lender to pay for your education, you can call it a student loan. Like any other loans, student loans are needed to be paid back on time, and as you know, they come with interest which keeps on building up over time.
Given this fact, smart individuals use their student loans dedicatedly for paying off tuition fees, books, and other study-related expenses. However, some legends dare to use that money for other adventurous stuff like exotic trips to Jamaica or ravishing parties in Miami.
A quick reminder for them is that student loans are not grants or scholarships. Whether you want it or not, you will have to pay it back. Good luck if you still want to use that money to sponsor your fun trips or midnight adventures.
Applying for Student Loans
You can apply for student loans by filling out the FAFSA form (Free Application for Federal Student Aid). The students need to put their financial information on the form, and then they can send it to the school of their choice.
Each school houses an office of financial assistance, which shoulders the responsibility of determining how much aid the applicant qualifies for. While filling out with FAFSA, eligible students can expect grants or scholarships, lucky they.
However, for those less fortunate, even the loan is not sanctioned. They have another alternative. They can simply apply for private student loans directly from the lender. However, be it a federal or private loan, signing up for a promissory note is mandatory. This promissory note acts as a legal document/agreement that holds the student’s consent about repayment. You can read this guide before applying for a student loan.
Options For Student Loan Repayments
You can have several alternatives to pay off your student loan. They include the following:
Graduated repayment plans: This plan lets you start with lower payments; however, they increase every couple of years. You need to pay off your entire loan balance within ten years. However, it’s available only in case of federal loans.
Income-based repayment plans: Here, you need to pay off your loan based on a percentage of your income. Typically, the percentage is 10-15% after deducting the amount for tax and personal expenses. In income-based repayment plans, you can get the payments recalculated every year. Besides, the lender may also adjust payments considering factors like the size of your family, current earnings, etc. It’s available for federal loans only.
Standard repayment plans: This is the most common repayment plan which features scheduled payments and fixed monthly payment amounts. For federal loans, the normal repayment tenure is ten years, and for private loans, it may vary.
Income-sensitive repayment plan: It’s another federal-only plan where the payments depend on your total income before other expenses and taxes. You need to pay off the loan amount in ten years. Apart from the ones mentioned above, there are other federal plans like income-contingent repayment, etc. For a private student loan, the rules for repayment may vary from one financial institution to another. You need to check with your lender before heading toward the application process. Many lenders provide student emergency loans with no job.
Consequences Of Non-payment
Ideally, you shouldn’t even think of not paying off your loan. However, things don’t always go the way you plan. Therefore, there might be scenarios where you can miss payments unintentionally. Missing payments, however, can cost you more in the long run. There are a few things that you can do when you miss your payments. However, remember, all of the given options will somehow increase your loan balance.
Deferment and Forbearance: Deferment and forbearance are temporary relief. It doesn’t want you to make payments temporarily. However, the interest will still count. Besides, deferment and forbearance have their own qualifying threshold, including unemployment, military work, etc.
Default: Missing payments are still ok, but defaulting can lead to ultra-serious consequences. You default loan when you keep on missing payments. In other words, you are a defaulter when you fail to pay back the loan according to the terms mentioned in the agreement. Defaulting your student loan may take you to court, ruin your credit score, and deprive you of future financial aid. Not funny at all!
Forgiveness: Though not everyone is eligible for this option, you can still give it a try. The eligibility options include working in the public sector (full-time) and making payments for ten years, working as a teacher in a low-income school for at least half a decade, etc. However, getting approved for forgiveness is more like getting a jackpot. Last year, only 1% of the applicants got approval for forgiveness. Tricky indeed, but not impossible!
FAQs Regarding Loan Balance
What increases your total student loan balance?
Like any other debt, student loans come with dedicated student loan interest rates. They may be cheaper than credit cards or personal loans, but they can still make a big hole in your pocket if you don’t pay them off smartly. When you delay your payments, choose to walk with an income-driven repayment plan, and pay lessers than requested, you may have to pay off an increased loan balance and interest payments. There are other influencing factors as well. Therefore it would help if you could go through them thoroughly.
Can your income affect your student loan eligibility?
Yes, it does. How much student loan you will get depends on your household income and your state of residence. Typically, most students get the approval of less than the maximum loan amount available.
What happens when you fail to pay your student loan?
When you don’t pay off your student loans, you can experience several consequences, none of which are sweet. Your credit score will drop, you won’t get future financial aid, you will have to pay late fees, and they will withhold your tax returns. In worst cases, the lender can garnish your wage, which may be as big as 25% of your disposable income. Apart from that, there may be potential lawsuits.
How to track student loan repayment progress?
Tracking your student loan progress is easy. For federal loans, you can visit studentaid.gov, while for private loans, you just need to check and visit your lender’s official website. After logging in, you can typically find your loan amount and balances, interest rates, current loan status, etc.
How long will it take to pay a $100,000 student loan?
It depends on your loan repayment tenure and the type of your chosen repayment plan. Typically, with a standard repayment plan, it may take up to 20 years to pay off your loan balance if you don’t come across a lot of financial obstacles on your way.
Conclusion: What Decreases Your Total Loan Balance?
Finally, you know what raises your overall loan balance, and things are under your control when you have the key.
Pay off your debts smartly, or take an emergency loans for bad credit, don’t default payments, avoid late fees, and pay off the entire due amount strategically at the earliest. This will help you save a lot of money that you pay because of capitalization.
