What increases your total loan balance – Understanding how loans work can be difficult, especially when understanding why your loan balance might increase over time. Let us break it down into simple terms: what increases your total loan balance and related concepts.
Taking Out a Loan
First off, people take out loans for many reasons. Maybe you had a big medical bill or needed some extra cash to cover your bills. Whatever the reason, you are not alone. In fact, as of late 2022, 22 million Americans had a personal loan.
What increases your total loan balance
When you take out a loan, the lender will add an interest rate to it. This means you have to pay back the amount you borrowed (the principal) plus some extra (the interest). Depending on the type of loan, the interest rate can make your loan balance grow over time. Here, we have discussed what increases your total loan balance:
Compounding Interest
In many cases, the interest on your loan can compound over time. This is called interest capitalization. This means that the interest you owe is added to your loan balance. Then, the next time interest is calculated, it is based on this higher balance. Over time, this can make your loan balance grow quite a bit.
APR vs Interest Rate
It is important to note that your annual percentage rate (APR) is not the same as your interest rate. The APR includes the interest rate plus any other fees associated with the loan.
Variable Interest Rates
A variable interest rate is an interest rate that can change over time. These rates are usually tied to a benchmark or index rate that changes based on market conditions. While variable rates can be attractive when interest rates are low, they can lead to high-interest debt if rates rise quickly.
For example, most credit cards have a variable interest rate. If you carry a balance on your card and interest rates rise quickly, your loan balance can grow unless you can make larger payments.
Making Minimum Payments
If you only make the minimum payment each month, you might pay less than the interest accruing each month. Your loan balance could increase even though you’re making payments.
Late Payments and Missed Payments
Your loan balance can grow if you make a late payment or miss a payment. Late payments can result in late fees, and your loan balance will continue to accrue interest. If you miss a payment, your loan balance will stay the same at first, but it will grow as it accrues more interest.
How to Avoid a Growing Loan Balance
Now that we understand what can cause a loan balance to grow, let us look at ways to prevent this.
Make On-Time Payments
Try to make your payments on time and for the full amount due. Consider setting up automatic payments if you have trouble remembering when to make payments.
Pay More Than the Minimum
If you can, pay more than the minimum payment each month. This can help you reduce your loan balance more quickly, reducing the amount of interest you will pay over time.
Consider a Fixed Interest Rate
If you have a loan with a variable interest rate, consider refinancing to a fixed interest rate. This can protect you from future interest rate increases.
Avoid Additional Borrowing
Try to avoid taking on additional debt while you are paying off your loan. Additional borrowing can increase your overall debt load and make it harder to pay down your loan.
Create a Budget
A budget can help you manage your money more effectively and ensure you have enough to make your loan payments each month.
Set Up Automatic Payments
Setting up automatic payments can help ensure you never miss a payment.
Consider a Lump Sum Payment
If you have some extra money, you might consider making a lump sum payment towards your loan. This can help reduce your balance and save you money on interest in the long run.
Be Careful When Taking Out Loans
Before you take out a loan, understand how much you can afford to repay. Try to find a loan with the best interest rate for your situation.
By understanding what increases your total loan balance, you can make a plan to avoid this and pay off your loan more quickly. Remember, it is always best to avoid late payments and pay more than the minimum when possible. Moreover, if you are considering taking out a loan, make sure you understand all the terms and conditions before you sign on the dotted line.
FAQs
What is a loan balance?
A loan balance is the amount of money you still owe to your lender. It decreases as you make payments and increases due to interest and fees.
How does interest affect my loan balance?
Interest is the cost of borrowing money. It is calculated as a percentage of your loan balance. The higher the interest rate, the more your loan balance grows.
What is compound interest?
Compound interest is interest calculated on the initial principal and also on the accumulated interest. This can cause your loan balance to grow faster.
How do late fees impact my loan balance?
If you miss a payment, you may be charged a late fee. This increases your loan balance and can lead to more interest charges.
How can I prevent my loan balance from growing?
Regular, on-time payments can help keep your loan balance from growing. Paying more than the minimum payment can also reduce the balance faster.
