When you take out a personal loan, you expect the balance to decrease as you make payments. Even though a decreasing balance is a common assumption, the balance can actually increase, even if you make on-time payments. In fact, it's common with certain types of loans. Consider this, about half of student loan borrowers have a higher loan balance after five years, according to a Moody's report. Fortunately, an increasing loan balance doesn't have to be your reality. Let's explore the FAQ, "What increases your total loan balance?" and the simple steps you can take to ensure your loan balance is trending in the right direction.
Understanding Your Current Loan Balance
Your loan balance represents more than the original amount you borrowed. It may also include accrued interest and other fees. Because of this, you should understand certain concepts that can impact your loan balance and the total cost of the loan.
- The principal amount is the amount of money you originally borrowed.
- The interest rate is the rate you pay the lender to compensate them for lending you money.
- The current balance is the total amount you owe as of today or within a limited period.
- Fees assessed represent the various fees you have been charged, such as insufficient payment, late payment, collections fees, or other services.
- The annual percentage rate (APR) is a percentage that represents the total finance charge on your loan over the whole term. It's a measure of the cost of your loan, including your interest rate and fees, on an annual basis. Compared to the current interest rate, APR is a more accurate representation of the cost of your loan.
- The payoff balance is the amount you would need to pay to completely pay off the loan. In most instances, the payoff balance includes your principal balance and any accrued interest charges up to a specific date.
What Makes a Loan Balance Increase?
In general, lenders will plan out your installment loan repayments over a time frame that decreases your balance gradually. However, several factors can cause your loan balance to increase. A few of those factors are explained below.
Understanding Amortization
Amortization is the process of scheduling a fixed-rate loan into equal payments over a specific period. Amortized loans have a definitive start date, number of payments, and end date. Many loans use the amortization financing process, including:
- Car loans
- Student loans
- Home equity loans
- Personal loans
- Fixed-rate mortgages
With amortization, you will make the same payment over the life of the loan. In the beginning, most of your ongoing payment will go toward interest. Over time, the amount of your ongoing payment attributed to the principal will increase, and the amount attributed to interest will decrease. This process increases until your loan is paid off. When your loan is amortized, you’ll have a clear minimum ongoing payment, but that minimum doesn't stop you from making extra payments. While the goal of amortization is to decrease your loan balance with every payment, negative amortization is a real scenario. With negative amortization, your balance may increase because the payments are not sufficient to cover the interest. The unpaid interest is rolled back into the amount you owe, causing your total balance to increase.
Paying Less Than Requested
No matter the type of loan, paying less than the minimum or requested amount can have negative impacts in more ways than one. For starters, lenders can add the remaining portion of the monthly payment back to your principal balance. In addition, if there are fees for paying less than requested, they can be added to your principal, which increases your loan balance. If an increasing loan balance was not enough, making less than the minimum amount can negatively impact your credit. This is because most lenders view anything less than the minimum ongoing payment as a missed payment.
Missing Payments
Missed payments can lower your credit score and will continue to appear on your credit report for up to seven years. Similar to paying less than the requested amount, missing monthly payments can cause your total loan balance to rise. The increase in your loan balance can be due to:
- Penalties
- Fees
- The missed payment amount being added back to your principal
- The added interest expense.
Even if the lender allows you to miss a payment, it can increase your total loan balance. Loan forbearance and deferments may allow you to pause or postpone payments. Depending on the type of loan, interest can still accrue during deferment, causing your total loan balance to rise.
Typically, loan forbearance and deferment payment arrangements are associated with student loans. However, the COVID-19 pandemic expanded these loan repayment measures to other types of loans. It is important to check with your loan provider to understand the specific terms and conditions that apply to your loan, as eligibility and options may vary depending on the type of loan and the lender's policies. In the end, missing a payment can have a negative snowball effect on your loan balance and financial situation.
How to Lower Your Loan Balance
Now that we've covered a few common scenarios that could increase your total loan balance, let's discuss how you can ensure your balance moves in the right direction.
Make Extra Payments
When you have an amortized loan, you will have a defined and set payment schedule. However, you don't have to stick to the repayment plan. Instead, you can make extra payments. In doing so, you can pay off the loan faster and ensure your loan balance is trending in the right direction — downward.
In addition to paying down your loan faster, making extra payments can save you money by reducing your total interest expense. If you're unable to schedule extra payments into your budget, simply paying more than the minimum monthly payment can have the same effect. It may help you pay the debt off faster and save on interest. Even small increases in your monthly loan payment can equate to substantial savings in the long run.
Apply for a Loan through Integra Credit
Understanding what increases your total loan balance is a fundamental component of financial literacy and building healthy financial habits. By taking the right steps to decrease your loan balance, you can possibly pay loans off faster and reduce the total loan expense.
Apply through Integra Credit for personal loan offers. Explore your options today.
