Imagine you’ve been making regular payments on a loan for months or years. One day, you log into your account and discover that the balance is more than it was originally.
What increases your loan balance like this? There are several possible explanations.
Can a Loan Amount Go Up?
Making payments on a loan will usually make the balance decrease. However, it’s possible for a loan balance to go up over time.
What increases your total loan balance? Many factors can be responsible for a rising balance.
What Increases Your Loan Balance Over Time?
So, what increases loan balance? Interest and capitalization, periods of non-payment, fees and penalties, and your repayment plan or strategy can all cause the balance of your loan to rise.
Interest and Capitalization
High-interest loans can easily grow to be greater than the original loan balance. However, even if your loan’s interest rate is relatively reasonable, it’s still possible for the loan to grow past the initial balance thanks to capitalization.
How does interest capitalization increase your total loan balance? Capitalization happens when interest on a loan is added to the principal, driving up the balance.
It also means you’re stuck paying interest on interest. If you aren’t careful, capitalization can quickly cause a loan balance to snowball.
Non-Payment Periods
It’s normal for your total loan balance to increase during deferment or repayment.
Interest continues to accrue during deferment, so the loan balance increases. If your payment doesn’t cover interest, your balance might even increase during repayment.
Fees and Penalties
If you’re wondering what increases the total loan balance over time, fees and penalties might be the culprit.
When you fail to make a loan payment on time, you could be charged a late-payment fee. Many lenders won’t charge this fee immediately. Instead, some have grace periods of several days.
For instance, if you miss the due date on your car loan payment, the lender might give you a week to make it up before they charge you a late fee.
Some loans may assign you a penalty interest rate if you make late payments. Penalty interest rates are more common with credit cards, but they sometimes apply to loans.
With a penalty interest rate, late payments trigger an increase in the interest rate you’re subject to. The duration of the higher interest rate depends on the terms of your loan agreement.
Default-Related Expenses
If you default on a loan, you may find yourself suddenly owing more than you thought. The balance can increase in a few different ways:
- Unpaid interest keeps getting added to the principal balance
- More significant late fees are imposed
- Collection costs are tacked on when the lender hires a collector to recover the balance
It’s always wise to do what you can to avoid defaulting on a loan.
Repayment Plans
A loan’s repayment plan (or your repayment behaviors) can also lead to an unexpected increase in your loan balance. This is especially true when your payments aren’t enough to cover the interest on your loan.
With each billing cycle, the interest your payment doesn’t cover will be added to the loan balance, causing it to grow over time. This process is known as “negative amortization,” and it can lead to a big problem: being underwater on a loan.
When you’re “underwater,” it means you owe more on the loan than the asset is actually worth.
In many cases, your scheduled loan payments will be more than enough to cover your interest each month.
However, negative amortization is possible on payment-option adjustable-rate mortgages (ARMs). These are mortgages that offer several payment options, some of which aren’t enough to pay all of the interest each billing cycle.
Negative amortization is also common with student loans. If you’re wondering what increases your total student loan balance, this is often the answer.
What Happens as the Term of a Loan Increases?
The longer a loan term is, the lower your monthly payments will be. However, you’ll end up paying more in interest when the loan term is longer. This is true even when loans have the same interest rate.
For example, imagine you take out a $5,000 loan at 10% interest. If the loan term is three years, you will pay the following:
- Monthly payment: $161.34
- Total interest paid: $808.09
- Total loan cost: $5,808.09
If you increase the loan term to five years, the amount you pay goes up considerably:
- Monthly payment: $106.24
- Total interest paid: $1,374.11
- Total loan cost: $6,374.11
Why Does My Student Loan Balance Increase Instead of Going Down?
Many student loan payments aren’t enough to cover interest. That interest is then added to the principal each billing cycle, making the balance increase.
What Is the Smartest Way to Pay Off a Loan?
You may not be able to control all the terms of your loan. However, if you’re careful about paying it off, you might be able to prevent (or at least reduce) the growth of your total loan balance.
Here are a few helpful tips:
- Be mindful of capitalization triggers and do your best to avoid them
- Pay more than the minimum payment when possible
- Make an effort to pay off interest early
Before you start repaying your loan, take time to create a deliberate repayment strategy. Tools like Bankrate’s free loan calculator can help you determine how much interest you’ll pay over time in different scenarios.
You might be amazed at the difference that a little extra payment each month can make.
The Right Moves Can Make a Difference in Your Financial Future
What increases your loan balance? When you take the time to understand the answer to that question, you’ll be empowered to take your finances into your own hands.
If you notice your loan balance starting to creep up, it’s time to make an extra payment or two. The faster you can pay down your balance, the sooner you can find financial freedom.
