Written By Melanie Lockert
What you owe on your student loans is likely more than you borrowed. It can be jarring to see your loan amount go up, compared to your principal balance. So what increases your student loan balance, exactly?
In many cases, interest is the culprit. Interest is the price of accessing loans. But if you leave interest unpaid, it can lead to a balloon effect, making paying off your loans difficult. Here are five situations that can lead to a student loan balance increase, and how to manage it.
1. Taking out unsubsidized or private loans
Unsubsidized loans differ from subsidized loans. For subsidized Direct Loans, the government pays for any interest that accrues during school, but if you have unsubsidized loans, the interest clock starts ticking as soon as the funds are disbursed. Similarly, interest begins accruing immediately after private loan funds are disbursed.
Even though you’re not required to make monthly student loan payments while in school, interest accrues daily. Due to this accruing interest, the amount you owe by the time repayment kicks in, can be more than you initially borrowed.
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2. Staying in school longer
When looking at what increases your student loan balance, interest accruing during school is a big one. Since interest charges begin once unsubsidized federal or private student loans are disbursed, the longer you’re in school, the more interest is added to your principal balance.
For example, let’s say you get your Bachelor’s degree, then immediately get your Master’s degree, and maybe even your Doctorate afterward. You also choose to defer your payments until you’re completely done with your education.
If you don’t make any payments while you’re in school, that interest has grown for six to 10 years or more, leading to a much higher student loan balance.
That’s why it’s a good idea to make interest-only payments during your studies, if you can afford it. Unfortunately, many students can’t or don’t, which increases the total amount you owe later.
3. Choosing deferment or forbearance
If you need to pause your monthly payments, you might consider a deferment or forbearance. While these options can help you in the short-term, they can lead to higher balances due to accrued interest over the long-term.
If you opt for deferment, whether interest continues to accrue is based on the type of loans you have. If you have subsidized loans, you’re in luck. The federal government covers the interest while in deferment. Other types of Direct Loans accrue interest in deferment, including:
- Unsubsidized Direct Loans
- Direct PLUS Loans
- Unsubsidized Direct Consolidation Loans
When deferment is over, the unpaid interest is capitalized. Interest capitalization is when the unpaid interest on your student loans is added to your principal balance. From there, you’ll pay interest on a higher balance, which increases costs over the life of the loan and leads to a higher monthly payment.
Under forbearance, interest continues accruing on all Direct Loans, no matter the type. However, the interest doesn’t capitalize at the end of your forbearance period. Though the interest doesn’t capitalize, you must still pay any interest that accrued.
4. Consolidating your loans
If you want to streamline your student loan repayment, you might consider a Direct Consolidation Loan. Through this option lets you combine several federal loans into one. Going this route might also open up some repayment or forgiveness opportunities as well.
Despite the advantages of consolidation, there are drawbacks to consider. Your student loan balance can increase due to consolidation due to:
- Capitalized interest
- A longer repayment term
During the consolidation process, any unpaid interest you currently have on your loans are tacked onto the principal balance for the Direct Consolidation Loan. That means a higher loan balance and more interest.
Additionally, a Direct Consolidation Loan can extend your repayment period. That can be beneficial now and offer you lower payments. But it significantly increases your interest and total borrowing cost.
5. Leaving IBR plan or no longer qualifying
The Income-Based Repayment (IBR) plan is one of the four income-driven repayment plans available. If you’re on this plan, there are three events that trigger interest capitalization:
- Leaving the IBR plan
- Not recertifying your income by the deadline
- Not meeting income eligibility requirements
If either of these situations occur, the remaining unpaid interest on your loans is lumped together with your principal balance, increasing your student loan balance.
Strategies to minimize student loan balances
When it comes down to it, what increases your student loan balances is the interest. This can vary based on time period, such as deferment, or your repayment plan like an IDR plan.
Your best bet is sticking to the default Standard Repayment Plan. It calculates payments so that your principal and interest are paid off over 10 years. However, this usually results in a higher monthly payment that might not be affordable for your budget.
If you can’t afford Standard Repayment Plan payments, here are other ways to minimize your student loan balances.
Borrow less money
Thinking about going back to school and taking on loans? Check out all your federal student aid options from the U.S. Department of Education, and through your school.
See if you qualify for any grants or scholarships that don’t need to be paid back. If you must borrow student loans, be mindful of how much you borrow. You don’t have to accept the entire student loan amount offered to you. If possible, borrow less money to keep your principal balance low.
Pay interest during school
If your student loans aren’t federally subsidized, then they’ll likely accrue interest while you’re in school. You might be studying for your next exam and in the background, your loan balance is creeping upward.
To keep it in check, make interest-only payments while going to school. You can arrange this with your loan servicer, or if you have private student loans, through your lender.
Make extra payments
You can reduce your student loan balance by making extra payments, on top of your minimum monthly payment. However, to make a big difference, you must ensure the extra payment goes toward your principal balance, not advanced to the following month’s payment.
Contact your loan servicer and let them know that you’d like your additional payment to go toward your principal only.
Enroll in an income-driven repayment plan
If you enroll in an income-driven repayment plan, you can reduce your monthly payments to a small percentage of your discretionary income. This can be a major benefit, but it also means that your payments won’t cover all of your interest charges.
Depending on your IDR plan, some interest subsidies are available to help:
- Saving on a Valuable Education Plan (SAVE). SAVE, which recently replaced REPAYE, has an amazing new benefit. If you make your monthly payment and it doesn’t cover all of your unpaid interest, the remaining unpaid interest is paid by the government and isn’t carried over to your balance.
- Pay As You Earn Plan (PAYE). Under PAYE the government covers any unpaid interest on your subsidized loans for three consecutive years after beginning repayment. After this three-year period, you’re responsible for covering the rest of the interest. Unsubsidized loans don’t qualify for this benefit.
- Income-Based Repayment Plan (IBR). Similar to PAYE, if you’re on IBR and have subsidized loans, the remaining interest that isn’t covered by your payment is subsidized by the government for up to three consecutive years. After that, it’s your responsibility. Unsubsidized loans don’t qualify for this benefit.
There are no interest subsidies for the Income-Contingent Repayment Plan. Additionally, interest no longer capitalizes if borrowers leave an IDR plan, with the exception of the IBR plan listed above.
Refinance student loans
The interest rate on your loans impacts how much you pay in interest. A higher rate means paying more in interest charges. If you have a higher interest rate, consider student loan refinancing.
Through private lenders, you might be eligible for a lower student loan refinance rate. That alone can reduce interest costs and make repayment more affordable. But if you have federal student loans, you might want to think twice.
Refinancing pays off the federal loans and converts them to a private loan. You’ll lose access to any of the federal loan benefits, like student loan forgiveness and IDR plans. If you’re absolutely sure you won’t need those benefits, it might be an option to explore.
Get student loan repayment under control
When looking at what increases your student loan balance, it’s mainly about interest and how it accrues during certain periods and on certain repayment plans. If you see your federal loan balance go up, but are pursuing forgiveness, then a growing balance doesn't matter as much since your goal is to have the remaining balance forgiven at the end of your repayment term.
Whether you’re pursuing forgiveness or not, get clarity around your student loans and how to strategically lower your student loan balance. Talk to an expert at Student Loan Planner. Our consultants help you create a repayment plan that’s tailored for your goals. Get in touch about a consult.
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