What increases your total loan balance?

From student loans to car loans, the average American pays almost $1,600 toward loans each month. You may be wondering, what increases your total loan balance? Let’s break it down.

What is a loan balance?

Before we get into stuff like balances and payment schedules, let's talk basics.

What is a loan, exactly?

A loan is money you borrow and promise to repay, usually with interest — a percent of the amount you borrowed. Lenders call that borrowed amount the "principal."

Interest is why you pay back more than you borrowed. If you borrow $10,000 and the interest works out to $1,500, you'll eventually pay $11,500.

Your loan balance is the amount you owe — principal plus interest — at a given time. 

What's behind a loan balance increase?

Let's say you make loan payments when you're supposed to and don't borrow more. Your loan balance should go down.

Most of the time, it will. But life happens, and some situations will increase your loan balance. Of course, you want to avoid that happening. So, what increases your total loan balance? 

High interest rates

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Interest rates can get pretty high. Take private student loans, which can have interest rates as high as 18%. 

Credit card interest rates are even higher — above 21.4% by the end of 2023. 

The higher your interest rate, the more the lender adds to your balance every month. If your payment isn't big enough, your balance could grow faster than you can pay it off.

Late or missed payments

If you’re late on a payment— or worse, miss it altogether — your lender might charge you a fee. That gets added to your balance.

Plus, you still owe the original payment amount.

The more payments you miss, the more late fees you'll end up with.

Interest + loan amount = capitalization

Lenders add interest to your account on a schedule, called "interest capitalization." Some lenders calculate how much interest you'll owe and add it to your balance before you start repayment. If you take a break from payment, they might add the amount of interest you've built up over the break. They'll add it to your balance before you start paying again. 

Other lenders add interest charges monthly or annually. They'll take how much you owe, multiply it by your interest rate, and add it to your balance. If your payment schedule doesn't keep up, your balance will grow.

When balances increase: Real-life scenarios

Let's talk about how people find themselves in situations where their loan balance increases.

Student loans

Student loans are many people's first experience with borrowing. You get approved for a certain amount, which goes directly to your school. You start paying them back after you graduate.

Today, the average student loan borrower owes more than $40,000. Some people owe way more than that, and paying off those loans is like shoveling in the middle of a blizzard.

Take Student Borrower Steve, for example:

A decade ago, Steve borrowed $130,000 at a 7% interest rate. Over the next 10 years, he paid off $6,000 a year — a total of $60,000. Finally, on the 10th anniversary of his college graduation, Steve owed… drumroll please… 

$147,000.

Yes, he owed more than what he started. The culprit? The amount he borrowed and the high interest rate.

Steve’s story may sound like a scare tactic, but he’s based on stories you find all over social media. Students borrow what they need to get their degrees, then end up stuck in debt for years.

Credit cards

Say you have a $5,000 balance and a 22% interest rate on your credit card. With all your other bills, you can afford to pay $200 per month on the card.

Your first payment shaves $112.50 off the original $5,000. The rest goes toward interest. Now, you owe $4,887.50.

At this rate, you'll pay off the card in just under three years. But that's only if you don't charge anything else to that card.

The thing is, life happens. Imagine you have to put a grocery bill on your card — or you just get tempted by something you really want.

We're all human, right?

So, you owe almost $4,900 after that first payment. You're on your way, slowly but surely. Then, you have to charge $200 for a car repair. Now, your balance is $5,100.

Say you still make your $200 payment. Your balance after that payment will be almost $4,990. 

Another $200 charge brings your balance to almost $5,200. Your next post-payment balance is $5,091 — higher than when you started trying to pay it off. 

Car loans

If you plan to buy a car and don't have about $26,500 lying around, you'll probably end up with a car loan. 

In some ways, car loans are easier to manage than credit card loans. You know up-front how much you need to borrow, and that amount won't go up. You can borrow less by buying a cheaper car or putting more money down.

But again, things happen. If you miss a payment date, your lender will probably charge you a late fee. Your balance will increase if you don't pay the amount due plus the fee.

Also, be aware of variable interest rates. The average interest on a car loan has been creeping up lately. If you have a variable interest rate, your interest will go up, too. 

Understanding types of debt

Your risk of balance increases depends a lot on what kind of debt you have. There are four basic types of debt:

• Structured debt: A loan with collateral, something valuable the lender can take if you don't pay

• Unsecured debt: A loan without collateral

• Installment debt: A loan with fixed monthly payments, such as a car loan or mortgage

• Revolving debt: A loan you can keep borrowing from, like a credit card

Unsecured debt has higher interest rates because it's riskier for lenders. Revolving debt makes it easy to borrow too much. Understand the ins and outs of your loan, and you'll be more prepared to prevent balance increases.

Tips for managing your loans

If you keep your borrowing under control, you can avoid scenarios that increase your total loan balance. 

• Only borrow what you need: You might need a student loan to meet your career goals, or a car loan to get to work. But if it's not a necessity, consider not charging it.

• Make bigger payments: Budget larger payments instead of paying the minimum on your credit cards and loans. Put any extra money into paying down your loan.

• Pay off credit cards in full: Don’t carry a balance month to month — that’s how you build up interest charges.

When in doubt, use a trustworthy loan repayment calculator. They help you plan how much you need to pay.

How to keep your balance manageable

So, now you know what increases your total loan balance: interest and not paying it off. If you borrow conservatively and pay back what you owe as soon as possible, you’ll be in the best possible position.

Most importantly, remember that you're never done learning how to manage your money. Greenlight is here to help you level up your financial literacy game with fun activities that help you manage your real-life money.