I’ve increasingly seen stories of people who have been making monthly payments on their student loans and their resulting balance goes up and not down. How does that even happen? Well, there are a few different reasons but the bigger concern is how detrimental it can be to your financial future. If this is happening to you then please make the necessary adjustments to set things straight.
Why Is My Student Loan Balance Increasing?
The simple answer to why my student loan balance is going up and not down is that your minimum payments are not covering the interest charged each month. This is called negative amortization. As a result, your balance continues to go up and not down. Even if there is a $1 difference in the wrong direction it will cost you a significant amount more over the life of the loan.
So, let’s break this down to make it clear as day. Each month, the amount you owe, called the principal balance, is charged interest which is a fee for borrowing the money.
I am going to go deep here on the numbers to show you what is happening and how it can spiral out of control quick. We paid off $107K in 33 months on regular incomes because we understood the numbers. We took control into our own hands and away from the lenders by doing exactly this.
Here is a quick lesson on how interest accrues and how it affects your payments. I previously wrote an article called How to Calculate Interest on Debt that will explain this further but here I want to simply focus on what happens when you pay less than the accruing interest.
The basic formula:
(principal x interest) / 12 = interest accrued per month
The resulting interest then gets added to the remaining balance from the past month. The minimum payment then gets subtracted from that balance. Your first red flag is when the interest charged is greater than your minimum payment. Let’s look at this with actual numbers. We assume the following.
Principal Balance – $10,000
Interest Rate – 5% (also can be written as .05)
($10,000 x .05) / 12 = $41.67 interest accrued per month
Based on that you would pay $41.67 in interest for that month. If your minimum payment is less than that then you will be negatively amortizing and your balance will go up each month. If it is more than that then you will cover the interest each month as well as start paying down principal. That is the critical part to paying off your loans.
Now, let’s look at how this snowballs each month.
Principal Balance of $10,000 + $41.67 (Interest accrued) – Minimum Payment = Resulting Principal Balance
The assumed minimum payment here is $100 a month.
MONTH 1: $10,000 + $41.67 – $100 = $9,941.67
MONTH 2: $9,941.67 + $41.42 – $100 = $9,883.09
MONTH 3: $9,883.09+ $41.18 – $100 = $9,824.27
Total Payment: $300
Total Principal Reduction: $175.73
Paying $100 a month will guarantee your loans are paid off in 10-11 years and would be close to a minimum payment you would see on a standard 10-year repayment plan.
You see how the balance at the end of each month goes down? That is what you want.
The assumed minimum payment here is $30 a month.
MONTH 1: $10,000 + $41.67 – $30 = $10,011.67
MONTH 2: $10,011.67+ $41.72 – $30 = $10,023.38
MONTH 3: $10,023.38+ $41.76 – $30 = $10,035.15
Total Payment: $90
Total Principal Reduction: $0
While you are paying less each month, which I understand might be desirable in the short term, you are basically throwing your money away. As you see, your principal balance is going up each month.
At this rate you will never pay it off unless you start paying more than the interest charged. It builds in the following manner.
2 years: $720 spent; $10,293.84 principal balance
5 years: $1,800 spent; $10,808.38 principal balance
10 years: $3,600 spent; $11,830.84 principal balance
You can see that while it may not seem like you are spending much initially as each month goes by you are increasing your burden for when you do start paying more than the interest charged. Not only is your principal balance going up but the interest charged increases a little bit each month too.
The point of all this math is to show you that it is worth it to do everything you can to pay more than the interest being charged each month. Typically, when a loan is set up by the lender and it has a 10 or a 20-year payoff period you will always be paying more than the interest charged.
Through the introduction of additional repayment plans is where things have gotten funny and ultimately bad for you.
What Causes These Low Payments?
Here are 3 common ways that might result in you paying less than interest is charged.
- Income Based or Income Driven Repayment Plan. If you are on an income based repayment plan typically your payment is 10-15% on your discretionary income. The intent of the plan is to help make your monthly payments more manageable. The downside is that it is possible your monthly payment does not cover the interest charged. You may not even know that when setting up the plan. This will result in your balance going up despite making payments. As your income increases and your payment goes up you will start to pay down the balance as you are paying more than the interest.
- Deferred Payments. If you submitted for deferment or forbearance on your loans it is possible that interest continued to accrue depending on the type of loan you had. As no payments are being made the interest causes the principal balance to go up every day. The benefit of doing this is that you at least keep your loans in good standing in the face of hardship. The downside is that you dig a deeper hole. My suggestion is to cut other things before you stop making payments on your student loans to avoid paying more in the long run.
- Fees. When you make a payment, the lender will apply the money in the following manner. It pays fees, then interest accrued since the last payment and then principal. If you had a fee or are accruing fees each month then you need to pay extra to cover them. Otherwise, your loan balance could go up as the combined fee and interest charge could be more than your minimum payment.
How to Fix It?
If you find yourself in this situation it is imperative you act to set it straight. I understand it might seem difficult to make work but your future self will thank you. There is so much to look forward to after being out of debt and it can be very fulfilling during the process of getting out of debt.
If you are on an income based repayment plan then look to transfer your loans to a standard repayment plan. Ideally you would do a 10-year loan but even up to a 25-year loan is better.
If your loans are currently deferred then you are most likely in a more difficult situation. You might be out of work, facing hardship or underemployed. If this is you then you are on the right path as you are seeking answers. First thing is get your income up and your expenses down. If you have to live with family do so. Look at options for refinancing to lower your interest rate but most importantly, find ways to make more money and get in control of your spending.
If you are accruing fees then you most likely are missing payments. Call your company and try having them removed. Either way, talk to them about your issue and work out a plan to set your account straight. Sell something or somethings if you need extra money. If you are simply forgetting payments then look to set up an automatic payment. If you are missing them because you don’t have enough money each month then discuss options to extend the payoff period of the loan. That is only a short-term solution though. You need to look hard in the mirror and find ways to raise your income and cut spending and prioritize these payments.
There is Hope
It might seem hopeless that after paying so much towards these loans for months or years they are higher now than before. There is hope though in that many people in your situation have been able to right the ship and get on a path towards debt freedom. Credit card debt is similar as well and maybe even more toxic.
Take control of your situation one step at a time. Don’t underestimate yourself. There are lots of resources on here you can review to help you but your biggest friend will simply be to believe in yourself. If that is difficult right now just know that if you spend less than you earn and take that difference and put it towards your loans you will come out on top. No matter how anxious or stressed you are right now the math always works in that case.
If you are experiencing an irregular amount of interest charged then please review Method 2 in this post of how to calculate interest. Most likely your interest is varying each month since it is being charged on a daily basis between payments.
A great tool that I developed to calculate your monthly interest is this Amortization Schedule with Extra Payments. This tool is beneficial because you will see how much money and time you can save by paying extra towards your loans. You can also put in your specific numbers to fully understand your situation.
These 6 Simple Steps to Get Out of Debt are a great place to start your overhaul and work towards debt freedom and financial success.
A great motivational tool is this Free Debt Thermometer Template. When you sign up for the amortization calculator you are automatically provided this tool. Be sure to download both and start using them.