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There are plenty of financial terms that you’ll come across when you borrow money from a financial institution. Your total loan balance is the most important, as it refers to the amount of money you owe your lenders.
The total loan balance refers to all costs associated with your loan, including the principal amount, interest, and any fees or additional charges. That balance can increase for many reasons, like variable interest rates, late fees and penalties, capitalized interest, and more.
Key Takeaways
Total loan balance refers to the total amount you owe a financial institution for the money you’ve borrowed from them. You’ll likely come across this term for whatever kind of borrowings you have, whether a personal loan, mortgage, or any other loan products you’ve agreed to take.
One important thing to understand is that the total loan balance will be more than the amount of cash you initially borrowed. Unfortunately, people who don’t understand that might get shocked and confused when they first see their total loan balance amount.
That’s because the total loan balance not only includes the principal amount (i.e. the amount of money you borrowed) but also includes other costs associated with that borrowing.
More specifically, your total loan balance will also include:
Being mindful of your total loan balance is essential for two reasons.
Some of these factors are based on your personal decisions, though some are beyond your control.
When taking out a loan, understanding the different types of interest is crucial for managing your finances effectively. Here are the main types of loan interest:
Fixed Interest Rate
Variable (or Adjustable) Interest Rate:
Simple Interest:
Compound Interest
Annual Percentage Rate (APR)
Prime Rate
Understanding these types of loan interest can help you make informed decisions when borrowing and managing loans. Always review your loan agreement carefully and consult with your lender to fully understand how interest will be applied to your loan. See the chart below for a full comparison.
| Type of Interest | Description | Common Uses | Pros | Cons |
|---|---|---|---|---|
| Fixed Interest Rate | Interest rate remains constant throughout the loan term. | Personal loans, mortgages, car loans | Predictable payments, easier budgeting | May start higher than variable rates |
| Variable Interest Rate | Interest rate can fluctuate based on market conditions or an index rate. | Some mortgages, credit cards, student loans | Potential for lower initial rates, may decrease over time | Payments can increase, harder to predict |
| Simple Interest | Calculated only on the principal amount of the loan. | Personal loans, car loans | Easier to predict, lower cost compared to compound interest | Less common, not suitable for all loan types |
| Compound Interest | Calculated on the principal and accumulated interest from previous periods. | Credit cards, some personal loans | Can grow savings quickly in investments | Can significantly increase total loan cost over time |
| Annual Percentage Rate (APR) | Includes interest rate and other loan-related fees, giving a comprehensive cost. | Most consumer loans like mortgages, car loans, credit cards | Easier to compare loan offers | May include additional costs that are not obvious upfront |
| Prime Rate | Interest rate charged by banks to their most creditworthy customers. | Benchmark for adjustable-rate mortgages, credit cards | Often lower rates for top-tier borrowers | Not directly available to average consumers |
When you take out a loan, you generally expect to make consistent payments over time. However, several factors can cause your loan payments to increase. Understanding these factors can help you manage your finances more effectively and avoid surprises. Here are three key factors that can cause your loan payment to go up:
We believe this is the most common for most Americans. For mortgages, lenders often require you to pay property taxes and homeowners insurance through an escrow account. This means a portion of your monthly mortgage payment goes towards these expenses. The lender then pays these bills on your behalf when they come due.
If property taxes or insurance premiums increase, your monthly mortgage payment will also rise to cover these higher costs. While these increases do not affect the principal balance of your loan, they do increase your overall monthly payment obligation.
If your property taxes increase by $600 per year and your homeowner's insurance premiums rise by $300 per year, your monthly mortgage payment will need to increase by $75 to cover these additional costs ($600 + $300 = $900 / 12 months = $75).
Many loans come with interest rates that can fluctuate based on changes in financial markets. These rates are referred to as variable rates for credit cards and adjustable rates for mortgages. In both cases, the lender ties your interest rate to an industry index, such as the prime rate for credit cards or the LIBOR (London Interbank Offered Rate) for mortgages.
When the index rate increases, your interest rate and corresponding monthly payment will also increase according to the terms of your loan agreement. This means that even if your loan principal remains the same, the total amount you need to repay will be higher due to the increased interest costs. Conversely, if the index rate decreases, your payments may go down.
For a mortgage with an adjustable rate, if the LIBOR increases from 2% to 3%, and your loan terms stipulate that your rate is the LIBOR plus 2%, your interest rate will rise from 4% to 5%, increasing your monthly payments.
Penalty interest rates are imposed by lenders as a consequence of late payments or other breaches of your loan agreement, such as a bounced check. These rates are significantly higher than your standard interest rate and serve as a deterrent against missed payments.
If you miss a payment, your lender might impose a penalty rate, which can dramatically increase your monthly payment amount. While this does not increase your loan balance, it does increase the overall cost of the loan, making it more expensive to pay off the debt over time.
If your credit card has an annual percentage rate (APR) of 15% but imposes a penalty rate of 29.99% for late payments, missing a payment can almost double your interest rate, leading to much higher monthly payments and total repayment costs.
By being aware of these factors, you can better manage your loan and prepare for potential increases in your monthly payments. It's essential to read and understand your loan agreement and stay informed about changes in interest rates, payment schedules, and any penalties that could affect your financial obligations.
As you read earlier, your total balance doesn’t just go down as you continue making regular payments. Instead, the amount can also go up either due to choices you’ve made or by circumstances beyond your control.
You can empower yourself by understanding all the factors to control your loan balance as much as possible. H
The first way a total loan balance can increase is with fees and penalties. These two things should seem pretty obvious to most people, especially those who have ever missed a payment deadline and have had to pay extra as a result.
Still, late fees aren’t the only extra charges in this category.
Remember that there are other administrative fees associated with loans. For example, the financial institution might charge processing fees, account maintenance fees, or even a fee for the initial application before you receive the loan.
Fees and penalties might not seem like much at first glance. But remember that they can add up quickly, especially the costlier ones like late fees.
Some loans come with the option of choosing fixed or variable interest rates. Fixed rates are straightforward, as the name suggests because they won’t change with time.
However, it’s the variable interest rates that you should be mindful of, as they can affect your total loan balance.
Variable interest rates are a double-edged sword that’s beyond anyone’s control. Even the financial institution you owe can’t do much about variable interest rates, despite how much they can impact your total loan balance.
On the one hand, these rates can go down when the overall economy is doing well. But as many homeowners and other borrowers learned the hard way in the past two decades, rising rates will drive up your total loan costs dramatically.
Typically, interest payments are included in the regular payments you make toward the loan. However, there are some instances when that interest goes unpaid.
A typical example is when you receive a loan deferment for something like a student loan. When that happens, a part of the interest goes unpaid despite continuing to accrue.
As a result, the unpaid interest is added to the principal amount, causing your overall loan balance to increase.
Capitalized interest has become a lot more common due to various programs to delay student loan payments, as well as the relief given to borrowers during the recent global pandemic.
Loan capitalization occurs when unpaid interest is added to the principal balance of a loan. This typically happens with student loans during periods of deferment, forbearance, or after the end of a grace period. Instead of paying interest as it accrues, the interest accumulates and is added to the loan's principal amount. This process increases the total amount owed, as future interest is then calculated on this new, higher principal balance.
For example, if you have a $10,000 loan with $1,000 in unpaid interest, capitalizing the interest would increase your loan balance to $11,000. From then on, interest would be calculated on the $11,000 rather than the original $10,000. This can significantly increase the overall cost of the loan over time.
Another factor that can drive up your total loan balance is making payments below the minimum required amount.
Although you’re still making regular payments to your lender, falling below the minimum amount is typically regarded as missing the payment deadline entirely.
So, while your payments might go towards reducing your loan balance, it can still lead to the same costly penalties and other charges that make the loan more expensive overall.
Suppose less-than-minimum payments can drive your total loan cost up, as described above. In that case, the same will undoubtedly happen if you miss your deadlines with late payments.
Not only do late payments affect your payment history and credit score, but they’ll also add costly late fees to your total loan balance.
Depending on the terms of your agreement, those late fees could grow even more significant if late payments happen multiple times throughout your loan tenure.
Lenders sometimes offer borrowers ways to ease their burdens, especially if they have trouble servicing their loans. These can come in many forms, like grace periods and forbearances, during which you might make smaller repayments or pause them entirely.
These things can provide you with financial relief, though they have their fair share of side effects.
For example, smaller payments and lengthier repayment periods could mean higher interest in the long run, making your total loan balance higher than before.
In a nutshell, refinancing means taking out a new loan to replace the current one. People refinance their loans for many reasons, like taking advantage of lower interest rates, changing the loan duration, and more.
However, people also refinance their loans for practical reasons. For instance, if people can no longer afford their monthly payments, they might refinance the loan to make those regular payments more manageable.
Sadly, the refinancing terms could mean a higher total loan cost as well. While the loan becomes easier to deal with in the short term, that happens at a higher total loan cost in the long run.
Lastly, your total loan balance can increase if you deliberately add to it by borrowing more money.
No system is perfect and calculation errors can increase your total loan amount. Algorithms that calculate the principal and interest can make a whole host of errors including capitalizing the loan improperly or even assigning you the wrong interest rate. Always do your due diligence and check the math on your loan.
By extending the repayment, you are effectively increasing the amount of time interest can build up and accrue on your loan. Of course, you may reduce your monthly payment, but you will pay more over time, and this increases your total loan amount.
Consider a personal installment loan of $10,000 with a fixed term of 3 years.
Understanding the total loan balance is crucial for effective budgeting and tracking any increases which may arise from fees or other factors. In this example, the total loan balance of $10,150 encompasses the principal and associated fees, providing a clear overview of the overall amount owed.
On the one hand, there are many reasons why your total loan balance might increase. You’ve discovered 8 of those reasons in the previous section.
Remember: your total loan balance can go down just the same as it can go up. There are several ways you can reduce the total cost quickly.
Suppose you’re still shopping around for a loan and are concerned about the total loan balance you’ll have to deal with.
In that case, your focus should be on choosing better loan terms upfront, even before signing on the dotted line.
Generally, you should only borrow what you need and not go beyond that figure. Take some time to calculate your precise needs and avoid the temptation of borrowing more than that despite anyone else’s encouragement to do so.
When you do those things successfully, you set yourself up for success by keeping your total loan amount as low as possible.
Suppose you’re already servicing an existing loan. In that case, the best thing you can do to reduce your total loan balance quickly is to always pay on time and in full.
Insufficient installment amounts will count as not meeting the minimum payment. In short, you did not pay your installment amount in full. This is another reason why your loan balance may increase.
Remember: prevention is always better than cure. In this case, what you’ll want to prevent is costly late fees and charges.
You can automate your payments to ensure that your total loan balance goes down as and when it should, without any late fees ever being added.
Another powerful way to pay off your total loan balance is to make extra payments whenever possible.
For example, you might get a bonus at work or make extra money on the side. You can channel those additional funds directly to your loan to help reduce the total balance faster than scheduled.
Never underestimate the power of micro-payments. Every dollar counts, so even making extra payments of $10 will go a long way toward reducing your debt.
Lastly, take advantage of any promotions or discounts your lender occasionally offers. For example, some lenders might provide discounts for automating your payments.
Even a tiny discount can go a very long way towards reducing what you owe. As you read earlier, every dollar counts and can make a significant impact on reducing your total loan balance.
Despite the deadline to repay your total loan balance, it’s still an excellent idea to pay it off early.
So, use these advantages by making extra payments and lowering your total loan balance as quickly as possible!
At this point, what you’ve learned is that the total loan balance is the whole amount you’ll owe a lender for the loan you’ve taken from them. The core of that total is the amount of money you borrowed, but there’s also much more to it than that.
Any interest, fees, penalties, and costs associated with that loan also count toward its total amount. Depending on market conditions and the choices you make, you could raise or lower that full amount. Doing the latter will benefit you more, of course.
Both accrual and capitalization can contribute to an increase in your total loan balance, but they operate in different ways.
In summary, both processes can lead to an increase, but accrual is the ongoing accumulation of interest, while capitalization is a one-time addition of accrued interest to the principal.
Simple interest is a straightforward method of calculating interest on a loan or investment. It is based solely on the initial principal amount and the interest rate. Unlike compound interest, which takes into account both the principal and the accumulated interest, simple interest only applies to the original amount.
Compound interest is a method of calculating interest on a principal amount that takes into account both the initial principal and the accumulated interest from previous periods. In essence, interest is calculated not only on the original sum but also on the interest that has been added to it. This leads to exponential growth in the total amount over time.
A debt avalanche is a method of repaying multiple debts strategically and cost-effectively.
This method aims to minimize the total interest paid over time, ultimately accelerating the overall debt repayment process. The debt avalanche strategy is known for its efficiency in reducing the financial burden associated with high-interest debts.
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