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| What Increases Your Total Loan Balance? (photo: www.allaboutcareers.com) |
No one has ever said "Student loans are a real relief!" It would be dishonest to do so. Currently, the United States is facing a student loan crisis with a total outstanding balance of 1.6 trillion dollars. This figure highlights the challenging nature of student loans. Many borrowers find themselves frustrated by the increasing loan balances, which seem inevitable. In fact, many borrowers report that their loan balances are much higher than the amount they originally borrowed.
Recent statistics show that approximately 50% of student loan borrowers face the problem of increased loan balances after five years. While some borrowers may incur late fees or miss payments, in many cases, borrowers have done nothing wrong but still end up with a bloated loan balance.
If you are unsure about what causes your loan balance to increase, read on. This post will help you understand the terminology related to your student loan and clear up any confusion.
What Is Interest?
Interest refers to the amount of money that a borrower is required to pay for the privilege of accessing funds when they are in need. The concept of interest emerged during the Renaissance period.
In ancient and medieval societies, the practice of charging interest was seen as morally questionable, as borrowing was often viewed as a last resort for those in desperate need. Furthermore, at that time, money was the only asset that was considered suitable for lending.
However, as society evolved, borrowing money became more commonplace and was no longer solely used to meet basic needs. People began to seek financial assistance for business expansion and to improve their financial situation. This shift in attitude made loans more widely accepted and created an opportunity for lenders to earn a profit. Gradually, money became a commodity, and the opportunity cost of lending it was considered a justifiable fee.
Today, interest is expressed as the Annual Percentage Rate (APR), and it can be divided into two types: simple and compound.
- Simple Interest
Simple interest is a straightforward method for calculating the interest rate on a loan. It involves multiplying the daily interest rate by the principal and the number of days between payments. This calculation is used for short-term loans, vehicle loans, and some mortgages.
The simple interest formula, as its name suggests, is quite simple: Simple Interest = P x I x N (where P = Principal, I = Daily interest rate, and N = the number of days between payments). Because simple interest is calculated on a daily basis, it can be beneficial for borrowers. For example, if you took out a $20,000 student loan to pay for one year of college tuition with an APR of 5%, you would need to pay off the loan over the next three years.
Using the simple interest formula, the amount of interest you would pay would be: $20,000 x .05 x 3 = $3,000. This means that the total amount you would need to repay would be $23,000 ($20,000 principal + $3,000 interest). If you make early payments, simple interest can help you pay off your loan faster by reducing your principal balance more quickly.
However, if you delay your payments, you will end up paying more interest than principal, and your final payment will be larger than your initial estimate. This occurs when you fail to pay off the principal within the stipulated time frame because you are not paying it at the expected rate.
- Compound Interest
Compound interest is the type of interest that is charged on both the principal and the accumulated interest. It can be explained using basic math concepts taught in school.
For instance, suppose you borrow $100 with an APR of 5%. At the end of the first year, you will owe a total of $105. At the end of the second year, you will owe $110.25, and so on until you fully pay off your loan. This amount adds up over time, leading to higher interest charges.
Whether your loan is subsidized or unsubsidized will determine your responsibility for paying the accruing interest. If you fail to pay the interest on an unsubsidized loan, your lender may choose to add the interest to your loan balance (capitalization), leading to a higher overall amount owed.
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What Is Capitalization?
Capitalization refers to the process of adding any unpaid interest to the principal loan balance, which can cause the total amount owed to increase. This usually occurs when loan payments are deferred or go unpaid.
While enrolled in school at least half-time or for six months after leaving school, you typically don't need to make payments on subsidized loans. However, for unsubsidized federal loans, interest continues to accrue during this period.
Once you begin making payments, any accrued interest will be added to your loan balance, causing it to increase. This can result in a much higher overall amount owed, depending on the repayment plan you have. Additionally, capitalization can increase your monthly payments.
What Makes Loan Balance Ascend?
There are various factors that contribute to an increase in loan balance, and it is important for borrowers to be aware of them to avoid unnecessary debt. While borrowers naturally want to minimize the interest they pay, lenders need to generate income to cover the risks involved in lending money. Here are some of the most common factors that can cause a loan balance to increase:
- Interest rates: The higher the interest rate, the more interest will accrue on the loan balance, which will cause it to increase.
- Unpaid interest: If the borrower defers payment on the interest that accrues on the loan, the unpaid interest will be added to the loan balance, causing it to increase.
- Late payments: Late payments on the loan can result in late fees and penalties, which will add to the loan balance.
- Capitalization: If the borrower has an unsubsidized loan, the interest that accrues during deferment or forbearance periods will be capitalized, which means that the interest will be added to the principal amount, causing the loan balance to increase.
- Extended loan terms: Extending the loan term can result in lower monthly payments but may also result in more interest accruing over the life of the loan, which can cause the loan balance to increase.
- Loan fees: Some loans come with origination fees, which are added to the loan balance, causing it to increase.
When it comes to loan repayment, delaying payments and making lesser payments than the requested amount can contribute to an increase in loan balance. Lenders typically expect timely repayments, but borrowers may face circumstances that cause them to delay payments. For example, students may not be able to make regular payments until after they complete their studies, which can lead to capitalization and a significant increase in the loan balance.
Additionally, if a borrower pays less than the requested amount, the loan balance can increase substantially. Private lenders may offer temporary reductions in payments, but interest continues to accumulate, resulting in a higher loan balance over time. While this may generate more income for lenders, it can be detrimental for borrowers as it increases their overall debt.
To err is human, and lenders are no exception. Mistakes in calculating loan balances can result in a higher loan balance for the borrower. Lenders may make incorrect calculations while making manual adjustments to the balance.
To protect yourself, it's a good idea to keep copies of loan statements and documents that you can use as evidence to prove that the lender made errors. If you believe there are errors, you can file a complaint with the Consumer Financial Protection Bureau (CFPB) to have them corrected.
How To Lower Your Loan Balance Gradually?
There are several ways to gradually reduce your loan balance and pay off your student loans more efficiently. Here are some tips:
Pay More Than the Minimum Payment: Making extra payments each month can significantly reduce the total cost of your loan over time. You can continue making monthly payments even after you've satisfied future payments to pay off your loan faster. Before making additional payments, confirm with your lender if the payments can be allocated to your higher-interest loans.
Opt-in for Automatic Debit: Signing up for auto-debit can reduce your interest rate by 0.25%. You can sign up for automatic deduction of your student loan payment with your lender by updating your details and giving your consent. Before signing up, check if your loan is eligible for the interest rate reduction.
Avoid Delayed Payments: Start paying off your student loan payments during the grace period or even when you are in school to avoid accruing interest. Paying in this way will help cover the monthly accrued interest and result in lesser interest capitalization, helping you reduce your principal loan balance.
Pay Loans with Tax Refunds: Dedicating your tax return to paying off your student loan debts is a convenient way to pay off your loan faster. Student loan interests are tax-exempt, so you can dedicate that amount to pay off that interest.
Loan Forgiveness/Repayment Alternatives: You can apply for a federal student loan forgiveness program if you meet the eligibility requirements. Different forgiveness and repayment programs are available for public servants, teachers, army personnel, etc. Apart from forgiveness, check with your employer to find out if they offer repayment assistance for student loans.
Try Out Snowballing:
The debt snowball method is an effective way to focus on a single debt at a time. Make the minimum payment on all your debts except the smallest one, and pay as much as you can on that small debt until it is paid off. Then move on to the next smallest loan amount. The snowball method works well for any loan, including student loans, mortgage loans, vehicle loans, etc., except payday loans, which have much higher interest rates and should be paid off as soon as possible.
Review Your Budget: Although it's not directly related to reducing your loan balance, assessing your budget can help you save money on loan payments. By earning more and spending less, you can adjust your budget and pay off your debts faster. This can include making extra payments, using the snowball method, and keeping funds available to pay interest on time. Taking the time to review your budget, removing unnecessary expenses, and distinguishing between needs and wants can all help bring down your total loan balance.
Consider Refinancing: Another option is to refinance your debt for a lower interest rate. This can save you a lot of money in interest and help you pay off your loan more quickly. You can use a debt consolidation program to refinance your student, personal, vehicle, or mortgage loans. You can also transfer debt to a balance transfer card with 0% APR for a set period.
Debt Avalanche: The debt avalanche strategy is similar to the snowball method but focuses on organizing debts by interest rate. This strategy is effective when you have multiple loans to pay off. To use the debt avalanche method, list all your loans and arrange them in order of the highest interest rate to the lowest. Then, start paying off the loans with the highest interest rates first while making minimum payments on every other debt. This approach can help reduce the total amount of interest you pay and lower your loan balance by making on-time payments.
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Understanding The Basics Of Student Loans
To better plan and avoid a significant increase in your loan balance, it's essential to have a clear understanding of the basics of student loans. Having already learned about repayments and ways to decrease the total loan balance, let's revisit this topic briefly. By understanding the finer details of student loans, you can make informed decisions and improve your financial position.
What Does a Student Loan Refer To?
A student loan is a type of loan obtained from either the government or a private lender to fund your education. Just like any other loan, student loans have to be repaid on time, with interest accumulating over time. It's wise to use your student loans strictly for paying tuition fees, buying books, and other study-related expenses. However, some individuals may choose to use the funds for non-educational purposes, such as going on exotic vacations or attending lavish parties.
It's important to remember that student loans are not grants or scholarships, and you are obligated to repay them. So, if you choose to use the money for personal expenses, you'll still have to repay it with interest. Good luck if you decide to use your student loan for fun trips or midnight adventures.
Applying for Student Loans
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| photo: Fox Business |
To apply for student loans, one must complete the FAFSA form (Free Application for Federal Student Aid) and provide their financial information. After submitting the form to the chosen school, the financial assistance office will determine the amount of aid the applicant is eligible to receive. Those who meet the criteria may be eligible for grants or scholarships.
However, for those who are not eligible for such aid, they can explore private student loans directly from the lender. Regardless of whether the loan is federal or private, signing a promissory note is mandatory. This document serves as a legal agreement in which the student agrees to repay the loan. Before applying for a student loan, it's recommended to read a guide to gain a better understanding of the process.
Options For Student Loan Repayments
There are multiple options available for you to repay your student loan. These options are as follows:
- Graduated repayment plans: This plan allows you to start with lower payments, but they increase every few years. You must pay off the entire loan balance within ten years. However, this option is only available for federal loans.
- Income-based repayment plans: With this option, you are required to pay a percentage of your income towards your loan repayment. Generally, the percentage is between 10-15%, after subtracting taxes and personal expenses. In this plan, you can have your payments recalculated every year, and your lender may adjust the payments based on factors such as family size and current earnings. Income-based repayment plans are also only available for federal loans.
- Standard repayment plans: This is the most commonly used repayment plan, where you make scheduled payments with fixed monthly amounts. The normal repayment period for federal loans is ten years, but it may vary for private loans.
- Income-sensitive repayment plan: Another option available only for federal loans, where your payments are based on your total income before taxes and other expenses. You must repay the loan within ten years. In addition to the plans mentioned above, there are other federal plans like income-contingent repayment, etc. However, the repayment rules for private student loans may differ among financial institutions, so it's advisable to check with your lender before starting the application process. Many lenders offer emergency student loans without requiring a job.
In an ideal situation, you should always prioritize paying off your student loan. However, unexpected situations can arise, and you might unintentionally miss some payments. But keep in mind that missing payments can result in a higher overall cost. If you do miss payments, there are a few options available to you, but they may increase your loan balance.
- Deferment and forbearance: These are temporary relief options that allow you to stop making payments for a specific period. However, interest will still accrue during this time, and there are qualifying thresholds for eligibility, such as unemployment or military service.
- Default: Missing payments is not recommended, but defaulting on your loan can lead to severe consequences. You default on your loan when you fail to make payments according to the terms of the agreement. Defaulting can result in legal action, damage to your credit score, and loss of future financial aid.
- Forgiveness: While not everyone is eligible for loan forgiveness, it's worth exploring if you meet the criteria. Eligibility options include working full-time in the public sector and making payments for ten years, or working as a teacher in a low-income school for at least five years. However, the approval process for forgiveness is challenging, with only 1% of applicants receiving approval last year.
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| photo: supermoney.com |
Student loans, like any other debt, come with dedicated interest rates. While they may be cheaper than credit cards or personal loans, failing to pay them off smartly can still be costly. Delaying payments, opting for income-driven repayment plans, or paying less than the requested amount can increase your loan balance and interest payments. There are other factors that can also influence your loan balance, so it's essential to thoroughly review them.
Your income can also affect your eligibility for student loans. The amount of student loan you receive depends on your household income and state of residence. Typically, most students are approved for less than the maximum loan amount available.
What are the consequences of failing to pay your student loan?
Failing to make payments on your student loan can lead to several negative consequences. Your credit score will suffer, you won't be eligible for future financial aid, and you may incur late fees. Additionally, your tax returns may be withheld, and your wages may be garnished by up to 25% of your disposable income. In some cases, you may also face potential lawsuits.
How can you track the progress of your student loan repayment?
It's easy to keep track of your student loan repayment progress. For federal loans, you can visit studentaid.gov, while for private loans, you should check your lender's official website. After logging in, you can view your loan balances, interest rates, current status, and other important information.
How long does it take to pay off a $100,000 student loan?
The length of time it takes to pay off a $100,000 student loan depends on the repayment plan you choose and the length of the repayment period. Typically, with a standard repayment plan, it may take up to 20 years to pay off the loan balance, assuming you do not face significant financial challenges.
In conclusion, you now understand what factors can increase your student loan balance, and you have the power to take control of your debt.
To decrease your total loan balance, it's important to manage your payments wisely, consider emergency loans for bad credit if needed, avoid defaulting on payments and late fees, and pay off the full amount strategically and as early as possible. By doing so, you can save a significant amount of money that would otherwise accumulate due to capitalization.
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