When you take out a loan, whether a federal, private or conventional loan, some interests accrue over a stipulated period of time that you have agreed with the lender. Of course, different lenders employ different strategies when it comes to issuing loans and so to interest types and rates.
Some factors that increase the total loan balance include making late payments, missing payments, periods of deferment, high credit card balances, paying less than the requested amount, taxable income, high debt-to-income ratio, a poor credit profile, and choosing an extended repayment period, among other factors.
If you are contemplating taking a loan, whether for business or studies, it is important to understand the principles surrounding loans and how to repay them to get your loan balance to a level that is not beyond your ability to repay.
In this article, I discuss everything you need to know about federal student loans and personal loans, interests, and repayment, among other valuable insights.
What Increases Your Total Loan Balance? An Introduction
Any loan that you borrow carries interest in it that you must repay. As you make payments towards clearing your loan, the loan balance will decrease with each full repayment, which is what banks or financial institutions expect you to do.
However, if you fail to repay the loan, or pay less than you are supposed to, then the amount you will have to pay eventually will increase. This is because, when the interests accrue, it adds up to the loan principal that is due, which is why the total loan amount will go up.
What Is Capitalization?
In business, capitalization means raising capital using debt or equity. The term can have different meanings and are of various types. In our case, capitalization means that the interests that have not been paid and have accrued are added to the principal.
Therefore, when you don’t repay your loan for a specific period of time, switch to a different repayment plan or take out a direct consolidation loan. The interest that accrues from the unpaid payment or deferment period will add to the principal balance. Therefore, when the principal increases, the interest that will accrue from the same will also go up.
What Is Interest?
Interest refers to the lenders’ rate for loans given to individuals, businesses, or groups. For investors, it means the amount of money you earn for your savings in financial institutions.
Different financial institutions charge different rates of interest on student loans, loans to individuals, and any other type of loans but within the regulations provided for by the Federal Reserve.
There are different types of interests, and each type has a different impact on the total loan balances you will have to clear at the end of your repayment period. These include:
- Fixed Interest – this is the easiest to understand since it is simple and straightforward. It is the amount of money you will repay in addition to the loan. The fixed interest does not change from when you take the loan to the time of repayment. Typically, fixed interests are short-term loans from individuals or loan dealers -shylocks.
- Variable Interest – this comes with variable interest rates. This is where the borrower pays interest based on the market value set by the bank or any lending institution. Most loans (excluding Perkins Loans) first disbursed before July 1, 2006, have variable interest rates.
- Prime Rate – is a particular type of interest that banks or lending institutions give to their favored customers for the loans they borrow. This type of interest is usually lower compared to some other kinds of interest.
- Annual Percentage Rate (APR) – this is the type of interest that credit card companies mainly use, and it refers to the total amount of interest calculated annually based on the total cost of your loan.
When calculating the annual percentage rate, banks apply a simple formula that adds the prime rate and the margin that the lender charges.
- Simple Interest – It is also called regular interest. It is the rate the banks or lenders charge for the loan for the entire period of the loan term. For example, if the simple interest is 5% for a period of 3 years, the lender calculates the interest by multiplying the principal with the rate, then multiplying it by the 3-year period.
- Compound Interest – In compound interest, the principal and interest increase with time since the accrued interest is added back to the principal before calculating the new interest for the next repayment.
These are just the common interest types that lenders across the world use. Of course, others, such as prime and discount rates, may also be used depending on the lender’s preference.
What Makes Loan Balances Go Up?
Generally, many factors would make a loan balance go up or increase. First, of course, every borrower would wish to pay a small interest on loans, and that depends on the rate that the bank or the lender applies on the loan and also the type of interest to pay on your loan agreement.
In most cases, some of the common factors that would make a loan balance go up include the following:
Delays In Paying the Loan Back
This is one of the reasons your loan balance goes up. Typically, banks or lenders have a punishment for defaulted loans or non-repayment. That means that when you take a loan and fail to pay it back or make late payments, there are always hefty penalties that affect your credit scores negatively.
Apart from that, when you delay in paying back the loan, for instance, in a case of a student who takes a federal student loan, by the time they graduate to a point where they can repay the loan, it might take a longer time than it was indicated in the agreement. So that delay in repayment can make your loan balances go up.
Choosing An Extended Payment Plan
There are advantages and disadvantages of choosing long repayment periods over short ones. An extended payment plan reduces your monthly payments to a small amount over a long period. That means you won’t feel any more impact on the loan repayment.
In addition to that, the extended repayment plan is available to most borrowers. That means almost anyone can qualify for an extended repayment plan since all federal loans offer it.
The negative impact of an extended repayment plan is that it increases the total loan balance. By the time you finish repaying your loan, you will have paid more than if you had chosen a short repayment period. For instance, if you take a $1000 loan to repay within six months, you will pay less than someone else with a repayment period of 2 years.
Most people, especially those on payroll, would opt for a long repayment period so that they can only pay a small amount every month, leaving them with something reasonable to remain with when the loans are deducted. This is an advantage in the short term, but eventually, you will have paid more than you would have if you had chosen a short repayment period.
The advantage of short repayment is that you get to finish your loan repayment early and end up paying less than for the extended plan. Therefore, it is always prudent to weigh options and, if you can, pay the loan off quickly to help reduce your interests.
Paying Less Than The Requested Amount
When you pay less than the requested amount, that also leads to a more loan balance that will reflect your overall repayment. For instance, if you are supposed to pay an interest of 10%, and you end up paying only 5% on the first year plus the principal payments, the 5% interest you have not paid will be added to the principal amount of your loan.
Therefore, it is crucial to be aware of this so that when making your repayments, you pay all that is due to avoid accruing the principal amount of your loan balance that will otherwise have a negative impact on the total repayment.
Missing Or Deferring Payments
Just like delaying in paying back your loan, missing a payment or deferring (postponement of repayment), or just not making a timely payment will impact the total loan amount that you will eventually pay.
Of course, banks are not risk-takers, and when you miss a payment unless you are on a student loan, you are likely to get penalized, and since you have collateral security for the loan, you may end up losing the assets that you have tied as security for the loan.
Sometimes, you may miss a payment on agreement with the lender or the bank, but that does not mean your loan balance will stop accruing. When you miss or defer payment to a later date on agreement with the bank or lender, the interest will keep accruing, which also adds to the principal amount of your loan, depending on the type of loan, as that happens to most loan types.
This will impact your loan balance, and eventually, your loan will go up.
Federal Income-Driven Plans
As the name suggests, this type of repayment plan works in that it makes it affordable for the borrower to repay the loan considering their annual income. It affects student loans and others that consider income and family size.
In this kind of repayment plan, the lender considers the income; therefore, the loan repayment is likely to be lower, which makes the loan balance go up. There are four types of income-driven repayment plans that include:
- PAYE Plan (Pay as You Earn Plan)
- Income Contingent Repayment Plan (IRC)
- Revised Pay as You Earn Plan (REPAYE)
- Income-Based Repayment Plan (IBR)
All these are based on income and are calculated differently. However, the fact remains that all these plans are not focused on making sure that you clear your loan fast but rather based on your income, and that sets the monthly minimum payments as low as possible, therefore would affect the overall federal student loan debt and loan balance, making it go up.
However, you will lose your rights under the federal loan programs if you choose to consolidate with a private loan lender. Therefore, borrowers should generally maximize their federal loan options before resorting to private loans.
Of course, sometimes, there are algorithmic errors that may make your loan balance go up. These calculation errors can happen due to confusion. Therefore, whenever you see a rise in your loan balance that comes with no reason from your side, it is essential to talk to your lender and check whether there are miscalculations that are affecting your balance.
Furthermore, Credit monitoring services are beneficial for disputing any errors with your credit cards and monitoring your credit accounts and credit reports. Credit reporting agencies update your balance information with the credit card issuer to keep collection calls at bay.
Make sure to make on-time payments regularly to help prevent errors.
How Does Student Loan Interest Work?
Every loan comes with terms and conditions. Student loans also come with terms you must comply with when the repayment time is due. While pursuing studies, it is important to understand your loan so that you are responsible for clearing the student loan balance when you graduate.
Whether a federal or private student loan, both come with interest, and you must repay after graduating. Federal student loan borrowers are either subsidized or unsubsidized. For a subsidized loan, the student who portrays the need benefits from this, while the rest of the students benefit from the unsubsidized loan.
For the subsidized loan, the federal government is responsible for paying all the interest while you are still studying. However, once you graduate, the government stops paying on your behalf, and you take full responsibility for your student loan payments.
Unfortunately, graduate and professional students are no longer eligible to receive subsidized loans as of 2010.
With unsubsidized loans, the interest on your federal student loan starts to accrue from when you take up the loan. However, you will pay all the interest when you graduate since the government doesn’t pay anything for unsubsidized loans.
How To Reduce How Much Interest You Pay On Student Loans
Of course, everyone would want to pay low-interest rates on student loans or any other type of loan. For student loans, there are methods that you can use to reduce the amount of interest that you will pay on your student loan.
Some of these methods include the following:
One way to lower the interest you pay on your student debt is to refinance the loan. To reduce the principal and interest portion of your monthly payment, you’ll need to find an interest rate you can qualify for. Shop and apply for refinance loans.
Contact multiple lenders and inquire about rates, fees, and lender qualification criteria for all eligible loans. That means you will pay less interest on your outstanding balance than you would otherwise pay towards your federal student loan.
Interest rates are typically based on influential factors such as your credit mix, so you may need a cosigner to help you secure more favorable terms to put you in stable financial health. Be cautious about refinancing federal loans, as doing so means you’ll lose access to thousands of dollars in federal benefits, such as interest subsidies.
Automate Your Payments
Another way to reduce the interest you pay on your student loans is to automate your regular payments. You can do this by signing up for autopay. Private lenders and federal loans always offer a 0.25% interest discount that you can benefit from when you sign up for autopay, which means your monthly loan payments are automated.
Seek Other Discounts
You may get other discounts from your student loan servicers, such as the M-Power financing while using autopay and loyalty discounts that are offered by your bank or credit union. To qualify for any of these discounts, you must meet some of their conditions, guaranteeing you a small interest rate discount that will help reduce your loan interest.
Another way to get a reduced interest on your loan is to negotiate with your lender. This is possible for a private student loan where you can negotiate with your lender on the interests and flexible repayment plan. When you negotiate, you may end up with an agreement to pay a lower interest rate than if you did not negotiate for it.
How To Decrease Your Total Loan Balance
I have already pointed out some of the factors that would make your loan balance go up. Whether as a student or for any loan, it is important to keep abreast of these factors to know how to decrease the same.
Of course, everyone would want to make on-time payments with less interest while paying off the loan. Therefore, if you want to help decrease your total loan balance, the following are some of the few tips that you should embrace:
Make Extra Repayments
As I indicated earlier, when you pay late, you may attract penalties from the lender, which generally increases the loan balance.
Making extra payments will help reduce the principal loan amount, affecting the subsequent interest you will pay. So eventually, you will pay less than when you stick to your repayment schedule. In addition to that, making extra payments will help you repay your entire loan balance on time; hence your credit limit increases due to a good credit score.
If you have some extra money, you can also make extra payments toward your credit card bills. Paying down your credit card balances and keeping your credit inquiries low could help raise your credit score.
Find A Lower Interest Rate
The type of loan that you choose will determine how much you will repay. Of course, different lenders have different interest policies and conditions. Some have higher rates, while others have lower interests.
Therefore, you have an option to choose that which suits your needs. And if you want to reduce your loan balance, then it is important to consider a lender with a low-interest rate.
Get A Temporary Interest Rate Reduction
In this case, federal student loans and private lenders work differently when offering a temporary interest rate reduction. For a federal loan, the only option is to extend your repayment period based on your income so that the repayment is spread within an extended period, attracting low monthly payments on future billing cycles.
When it comes to private loans, you can negotiate with the lender to give you a temporary interest rate reduction for a period when you think you cannot come up with the entire amount to repay. For example, this is the case if you are going through financial hardship.
Pay Back Your Most Expensive Loans First
Expensive loans are those that attract high-interest rates. If you have loans from different lenders, A good rule of thumb is to consider paying off the one with the most significant balance first. However, that does not mean you should ignore the lower interest rate lender.
Of course, if you miss or delay the one with high interest, and perhaps you took a huge loan, the interest may accrue faster, adding to the principal and making it difficult for you to make future payments. That means you will end up with even a higher loan balance that you may not be able to pay off within the agreed timelines.
Therefore, it is important to consider repaying the most expensive loan before the less expensive one. This will help you keep within the limits where you can pay all your loans without letting them go beyond what you can afford to repay.
At this point, you now have insights that you can apply to make monthly on-time payments on your loan to avoid getting your loan balance at higher levels that attract a lot of interest. When you repay or finish your loan faster or on time, your payment history calculates your credit limit, which will affect your next loan if you take another.