What Increases Your Total Loan Balance?

Written By
G. Dautovic
October 14,2023

In general, you expect loan balances to go down over time as you make repayments. Unfortunately, however, loan amounts can also go up, even if you pay back money.

According to research by Moody’s, almost half of student loan borrowers are further in debt five years after they begin paying back their loans.

In this post, we take a look at what increases your total loan balance, what interest capitalization is, and what you can do to prevent it. After all, who wants to be paying back their student loan - or any other loan - for the rest of their lives?

What Makes Loan Balances Go Up?

Generally, loan issuers will plan your repayments so that, over time, the size of the outstanding balance will go down. Because of capitalized interest, progress will initially be modest.

However, as the total value of the loan declines, so too will the balance. Eventually, interest payments will be minimal, and you will repay the loan in full. 

Interest capitalization is, by definition, adding the amount of unpaid interest to the principal (the initial sum of money you borrowed), which effectively increases both the principal and the interest you’ll have to pay on it in the future. 

How fast you repay depends on the loan term. Standard repayment on, for example, federal student loans is 10 years, while for students who took out private loans, it varies from 5 to 15 years

However, various factors can interrupt your loan repayment progress – some of which you wouldn’t normally consider. Let’s now discuss what increases your total loan balance.

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Paying Less Than the Requested Amount

If you pay less of your loan back than the requested amount, it can still rise in value, even if you are putting money into it. 

How does interest capitalization affect a loan? It leads to exponential increases in the outstanding balance owed. 

Suppose, for instance, you have a $40,000 student loan at 5% interest. The loan term is 20 years. If you pay back $1,000 at the end of the first year, you’ll reduce the principal to $39,000.

However, the lender will charge interest of $2,000, putting the total loan value up to $41,000 after the $1,000 repayment. 

To reduce your debt, each month, you must make a monthly loan payment that’ll cover both the principal payment and the capitalized interest on your student loan.

For the above example, that would mean you’d need to fork out more than $3,000 per year. 

Delays in Paying the Loan Back

When you take out a loan, you don’t usually make repayments on it immediately. Instead, there is a delay, depending on the purpose of the loan. 

For instance, most students don’t make loan repayments while attending university. Consequently, the capitalization of interest causes their loans to grow while they study.

For example, a $40,000 loan charging 5% per year will grow to $48,620 over a four-year course when compounded annually.

So, when you come to take your final exams, your loan balance will likely be considerably higher than in your freshman year. 

Missing or Deferring Payments

Just like paying less than the requested amount, taking advantage of forbearance (where you temporarily stop making payments) or deferring payments will capitalize a loan – in other words, increase its value. 

Lenders typically give students a six-month grace period at the end of their studies before demanding loan repayments. This gives them time to find a job, start earning money and meet some of their initial costs.

However, even during the grace period, interest on the loan continues to accrue.

Income-Driven Payments

Federal income-driven plans ask borrowers to pay back what they can afford based on their monthly salary, not sums of money that will actually clear their student debt.

For this reason, loan repayment amounts are sometimes less than interest charges, causing balances to rise slowly over time. 

Choosing an Extended Payment Plan

Extended payment plans are loans that typically last for 20 years or more before being paid off in full. These typically reduce the size of the loan over time, but much more slowly.

When you pay over a longer period, you wind up owing lenders considerably more interest. In return, the monthly payments are smaller, giving you more disposable income today. 

Again, if you miss payments on an extended plan, your total loan balance may rise. That’s because for the first few years, payments usually only cover interest plus a tiny bit extra.

Missing a single payment per year can land you right back where you started. 


Finally, balances or loan capitalization may increase because of calculation errors. If you notice that your balance suddenly shoots up although you’ve been making all the correct payments, query it.

Problems may arise for many reasons, including wrong payment amounts, algorithmic errors, or mixing your account up with somebody else’s.

How To Lower Your Loan Balance

To lower your outstanding loan balance, you need to:

Make Extra Repayments

You don’t necessarily have to stick to the repayment schedule specified by the lender. Making extra payments is always an option. The faster you can pay off the principal, the better. 

When you make extra payments, you first cover the cost of any fees relating to the administration of your account. (These are usually quite low). You then pay off the interest and then, finally, the principal itself.

Even small increases in monthly loan repayments can lead to tremendous savings in the long-run. 

Find a Lower Interest Rate

When it comes to repaying loans, the principal is rarely the problem. Instead, it is the capitalization of interest that causes financial hardship.

Charging students 5%-7% percent per year makes it challenging to pay back loans, particularly during the early phase of their careers when they are earning the least. 

Shopping around for lower interest rates can help tremendously. Many lenders offer interest rates of less than 3% to domestic students, making loans considerably more manageable.

For instance, on $40,000 at 3%, you’d “only” have to repay $1,200 per year to keep the balance constant. More than that would reduce the principal, slashing your future payments. 

Become a REPAYE Plan Member

If you’re on a federal income-driven plan, and your monthly payments are below the interest charged on your loan, sign up to the REPAYE plan.

This forgives 50% of the unpaid interest to be capitalized each month, making your loan more manageable. For instance, if the interest on your balance is $100 per month, this facility will lower it to $50. 

Get a Temporary Interest Rate Reduction

While public lenders typically offer the lowest rates on student loans, some people may be able to find additional relief by going to private lenders.

Many offer rate reduction programs that allow you to temporarily reduce the interest rate on your loan, helping you pay off more of the principal. 

Pay Back Your Most Expensive Loans First

When paying back loans, always choose the most expensive one first. For most people, that’s likely to be your student loan (unless you have credit card or personal loan debt).

Remember, you can’t free yourself from student loans, even with bankruptcy, so repaying them as early as possible is a priority for your financial safety. In some cases, it may be worth prioritizing your student debt over all other loans. 

How To Avoid Paying Capitalized Interest

What happens when interest is capitalized on your loan? Generally, it means that you have to pay back more, sometimes to the point where it can become unsustainable. 

There are two things you need to do to avoid capitalized interest from accruing on your loan:

  1. Pay off interest before the lender adds it to your balance.
  2. If you can, start paying off your loan while you’re still in school.

Paying off interest before the lender adds it to your balance requires making higher monthly payments during the grace period.

If you increase your repayment amounts, you can offset the additional interest you might accrue. 

To prevent loan interest from building up as you study, also consider making early repayments. You can do this either out of savings or by getting a side job while you study.

Learning what increases your total loan balance early on can wind up saving you large sums of money over the life of the loan. 


How can you reduce your total loan cost?


You can reduce loan charge capitalization (the amount of interest you’re charged) by making regular payments, starting early with your loan repayments (including while you are still a student), and switching to a lower interest rate loan. 

What happens when interest is capitalized on your loan?


When you don’t repay your loan, interest compounds, increasing the total amount you have to pay back. This extra interest is called capitalized interest or loan capitalization. 

What is capitalized interest on a student loan?


Capitalized interest refers to the amount of interest owed on the principal plus compound interest. So, for instance, the principal might be $40,000, and the rate is 5%.

Without repayment, the principal plus compound interest is $42,000 after one year. The new captalized interest is, therefore, $42,000 x 0.05 = $2,100 - higher than before.

What is the difference between capitalized and accrued interest?


When discussing accrued interest vs. capitalized interest, we’re, in fact, talking about very subtle differences in meaning that mostly concern the speaker’s viewpoint and the context.

Both types of interest are accrued - that is to say, accumulated - and both are added to the principal, increasing both the principal and the interest that has to be paid on it in the future.

However, we mostly talk about accrued interest in the context of savings accounts, while capitalized interest is something you’ll come across when reading about loans and what increases your total loan balance. 

For companies, the difference between the two concerns the way the interest is recognized in accounting - as an interest expense in the current period (accrued interest) or as part of the loan balance (capitalized interest).

About author

I have always thought of myself as a writer, but I began my career as a data operator with a large fintech firm. This position proved invaluable for learning how banks and other financial institutions operate. Daily correspondence with banking experts gave me insight into the systems and policies that power the economy. When I got the chance to translate my experience into words, I gladly joined the smart, enthusiastic Fortunly team.

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