Why Is Your Student Loan Balance Not Decreasing?
Your Outstanding Balance Is High
One of the main reasons why a balance may not be declining is an extremely high outstanding principal balance. Most student loans calculate the interest using capitalization.
For instance, say you took out a loan for $200,000 at a rate of 6% for 25 years. This means you’ll be paying a monthly amount of $1,288.60 for a total of 300 months. So, the total interest you’ll pay by the end of the term will be $186,580.84.
The payments you make are first applied to the interest, and then the remaining amount is applied to the principal. This process keeps repeating until the end of the term. Accordingly, when your balance is high, most of the money will be going towards the interest and not to the principal.
High Interest Rates
Another reason for a slow decrease in the overall debt is a higher interest rate. For instance, you and your friend took out $150,000 each. Assume your friend received a rate of 6% and you obtained a rate of 7%. Both of you make $1000 as payments every month.
At this rate, your friend will pay a total interest of $127,952. They can clear off the total debt after making regular payments for 278 consecutive months. On the other hand, at a 7% rate, you’ll have to pay a total interest of $207,515 and you can clear off the debt after making consecutive payments for 358 months. As you can see, a mere 1% difference in interest rates means that you’ll end up paying almost $80,000 extra as interest plus an extended term of almost 6 months.
You're Paying Less Than The Interest That Is Accruing
If you’ve applied for federal relief programs such as an income-driven repayment plan, deferment, or forbearance, your outstanding balance will increase and most of your payments won’t be able to cover the balance.
- When you opt for an income-driven repayment plan, you’ll be asked to pay 10% to 15% of your monthly discretionary income. While it helps to manage your bills, it won’t help cover the interest charged on the loan. This will result in negative amortization and your principal outstanding will keep going up even if you make regular payments.
- When you opt for deferment or forbearance, the interest will still accrue over the period of non-payment. As long as you don’t make payments, this accrued interest will get added to the principal (known as capitalization), thus increasing the total debt. Once you start making regular payments, all of the amounts will be applied to the interest, not the principal.
- For every payment you make on the loan, the lender applies the sum in the following order - fees, accrued interest, and then the outstanding principal. If your loan accrues fees every month, you’ll need to shell out extra money. If you can’t do that, your loan balance will keep increasing.
How To Fix It
If you realize your loan balance isn’t decreasing, it’s important that you fix it immediately. Here are some measures you can take:
- If you’ve opted for an income-driven repayment plan, consider resetting it to the standard repayment term.
- Try increasing your income by taking on side jobs while working simultaneously to reduce your expenses. Build a strategy to cut out unnecessary costs and use the leftover funds to pay the debt.
- Make extra payments than the recommended sum per month. This will help you chip off the outstanding principal and you’ll start seeing substantial decreases in the overall balance.
- If you’re accruing unnecessary fees due to missed payments, talk to your lender to find a better alternative. Depending on your credit rating and other requirements, you might even try to refinance the student loan for a better rate and term.
There’s no definitive approach to get out of this problem as the reasons for unchanged loan balances vary. It’s imperative that you make regular payments, possibly more than what you owe each month. Build a strategy and take control of your expenses to ensure that you don’t create a debt trap for yourself.
Most importantly, speak to your lender if you’re facing financial hardship and follow the steps listed above to transform the rising outstanding amount into a more manageable figure.