Growing student loan balances are a very frustrating and very real problem.
I frequently receive emails from borrowers who have much larger balances on their debt than what they originally borrowed. In some cases the larger balances can be explained by missed payments and late fees. However, in many cases, the borrower hasn’t done anything wrong, yet the balance has still increased.
Today we will look at the ways a student loan balance can go up and cover some strategies to prevent it from happening.
What causes a student loan balance to increase?
The most simple explanation for balance growth is the interest. Student loan accrue interest daily. Once a month, lenders add that accrued interest to the principal balance and borrowers pay interest on that interest. This vicious cycle can cause a balance to grow out of control quickly.
Borrowers making timely payments reasonably expect that their balance should be lower due to their efforts. Unfortunately, that isn’t always the case. A number of issues get in the way:
Growth During School – Most borrowers do not make payments during school. However, interest still grows on the loan during school (the one exception would be a federal subsidized loan). For many, this can mean years of growth and compounding interest. As a result many borrowers enter repayment with a balance significantly larger than what they actually borrowed.
Deferments and Forbearances – Many lenders will allow struggling borrowers to take a break during repayment. Most lenders also give students a six month “grace period” after finishing school. Even though there is no bill due, the interest is still working for the lender and growing the balance.
Income-Driven Payments – This issue is unique to federal loans. Because federal income-driven plans allow borrowers to make payments based upon what they can afford rather than what they owe, it is possible that the monthly interest on the loan is greater than the monthly payment. When this happens the total debt will go up with each passing month.
Payments requiring less than the monthly interest accumulation – Sometimes private lenders will allow borrowers to have a temporary reduction in the amount they are expected to pay each month. While this provides a break for borrowers, the interest usually will continue to accumulate. The smaller payments help the borrowers stay current, but they help the lenders make some extra money from the extra interest.
Extended Repayment Plans – Some repayment plans are designed to take 20 years or more before the loan is paid off. On these extended repayment plans it can take years for the loan balance to drop below the original amount that was borrowed. This is because the interest accumulation during school caused the balance to grow and the majority of the payments went to interest rather than principal.
Calculation Errors – Lenders are not perfect and it is possible that an error may have been made. This is especially true if any manual adjustments were made to the balance. Borrowers should keep copies of loan statements and documents so that they can prove an error was made.
There are a number of reasons that a balance may have increased beyond the original amount borrowed. The good news is that there are several tools and strategies that a borrower can use in order to get the balance lowered.
Lowering the Principal Balance on Loans
Make Extra Payments – The most common and most effective way to lower a student loan balance is to make extra payments. When borrowers make payments, the money is first applied to any fees, then covers accumulated interest, and then lowers the principal balance. Because the monthly payment normally covers these three categories, extra payments will go entirely towards principal. Even a little bit extra can make a huge difference in the long run.
Get Real Lender Assistance – Federal loans may have the best terms, but some private lenders have been known to occasionally help out borrowers that are really struggling. As an example, Navient has what is called the Rate Reduction Program. On this program, borrowers who have payments larger than they can afford can get temporary reductions in their interest rate. This interest rate reduction means more of the payment will go towards the principal balance.
Remember to Attack the Highest Interest Rate Loan First – The biggest enemy to eliminating student debt is interest rates. The higher the interest rate, the more difficult it is to eliminate the loan. By focusing on eliminating the loan with the highest interest rate first, borrowers can get their loans paid off as quickly as possible while minimizing how much is spent over the life of the loans. Some people choose to pay a little extra on all of their loans, but it is far more effective to focus everything on a single loan.
Sign Up for the REPAYE Plan – Though there are many federal income-driven repayment plans, one of them has a special perk for borrowers whose monthly payments are less than the monthly interest. The REPAYE plan will immediately forgive half of the extra interest that accumulates each month. That means if a borrower has loans that generate $200 of interest per month, but the borrower is only required to pay $50 per month, instead of having the balance grow by $150 per month, it will only grow by $75 per month on REPAYE. Switching to REPAYE won’t stop the balance from increasing, but it will slow it down.
Find Lower Interest Rates – If interest is the enemy, getting lower interest rates is one of the best ways to get balances under control. Lenders like SoFi, Laurel Road, and CommonBond all offer interest rates below 3%. These lenders can be picky about credit approvals, so it is a good idea to shop around and check rates with many of the lenders offering student loan refinancing.
One Last Bit of Good News…
As borrowers begin repayment, most of their payment will go towards interest with only a small amount being used to reduce the principal balance. However, as the balance drops, the monthly interest that accumulates will also drop. This means that same student loan payment will go further towards eliminating the principal balance with each passing month.
Just as setbacks can cause a student loan balance to spiral out of control, positive progress can likewise build momentum.