What Causes Your Loan Balance to Increase?
Uncover the financial dynamics that can lead to an increase in your loan balance, even when you're making payments.
A loan balance represents the total amount of money a borrower still owes to a lender. This amount includes the original sum borrowed, known as the principal, along with any accumulated interest. While regular payments are typically structured to gradually reduce this balance, certain circumstances can lead to an unexpected increase in the amount owed. Understanding these factors is important for managing debt effectively.
Accrued Interest and Capitalization
Interest accrues on a loan over time. If payments do not cover the full amount of interest due, the unpaid portion can be added to the principal. This process is known as interest capitalization, and it directly increases the total amount owed, leading to interest being charged on a larger principal balance. This is particularly common in situations where loan payments are deferred or are insufficient to cover the full interest.
A significant way a loan balance can increase due to interest is through negative amortization. This occurs when scheduled loan payments are less than the interest accrued during the payment period. The unpaid interest is then added to the principal balance, causing the total amount owed to grow even while the borrower is making payments.
Certain types of loans frequently experience interest capitalization or negative amortization. For instance, some student loans allow for deferment or forbearance periods where interest continues to accrue. If this accrued interest is not paid, it can be capitalized, increasing the loan’s principal. Similarly, some adjustable-rate mortgages or construction loans may feature payment structures where initial payments are interest-only or even less than the accrued interest, leading to negative amortization during specific phases of the loan term.
The federal student loan system has recognized the impact of negative amortization, with programs like the Income-Driven Repayment (IDR) plans, such as the SAVE plan, designed to address this. Under the SAVE plan, if a borrower’s monthly payment does not cover the full amount of interest due, the government may cover the shortfall. This prevents the loan balance from increasing due to unpaid interest.
Loan-Related Fees and Penalties
Beyond interest, a loan’s balance can grow due to various fees and penalties applied by the lender. These charges often arise from the borrower’s failure to adhere to the loan agreement’s terms. When these fees are not paid immediately, they can be added directly to the outstanding principal balance, thereby increasing the total debt.
Common examples include late payment fees, assessed when a scheduled payment is not made by its due date, or missed payment fees. These fees can be a flat rate or a percentage of the overdue amount, and their capitalization increases the overall loan balance. Default fees or administrative charges incurred by the lender due to borrower non-compliance, such as costs associated with managing a delinquent account, can also be capitalized into the loan.
It is important to differentiate these from upfront fees, such as origination fees, which are typically paid at the time the loan is disbursed. While origination fees reduce the net amount received by the borrower, they are usually deducted from the loan proceeds or paid at closing and do not increase the principal balance after the loan has been originated. Fees that are added to the principal balance generally occur after loan origination and are a direct consequence of actions or inactions during the repayment period, causing the debt to grow. Legal fees incurred by the lender to enforce the loan agreement, particularly during a default scenario, can also be added to the outstanding balance. These can include costs for collection efforts or legal proceedings.
Additional Advances and Lender-Assumed Costs
A loan balance can also increase when additional funds are advanced by the lender, either at the borrower’s request or on their behalf. For revolving lines of credit, such as a Home Equity Line of Credit (HELOC) or a construction loan, drawing additional funds directly increases the outstanding balance. Each draw adds to the principal, reflecting the flexible nature of these credit products. This allows borrowers to access more funds, but it expands the total debt.
In other scenarios, a lender may advance funds to cover costs that are contractually the borrower’s responsibility, especially in cases of default or non-compliance. For example, if a homeowner fails to pay property taxes or maintain required insurance coverage, the mortgage lender may step in to pay these obligations to protect their interest in the property. The amounts paid by the lender for delinquent property taxes or insurance premiums are then added to the outstanding mortgage principal. This ensures that the lender recovers these expenditures and maintains the collateral’s value.
Similarly, if a loan defaults, the lender may incur various collection costs, such as legal fees, property preservation expenses, or foreclosure costs. These lender-assumed costs are often permitted by the loan agreement to be added to the defaulted loan balance. The capitalization of these expenses increases the total amount the borrower must repay to resolve the default.