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Interest can cause your student loan balance to increase over time.
If you’re not paying enough to cover the growing interest on the loan each month, a ballooning balance can happen even as you’re making payments. This frustrating cycle is called negative amortization.
Interest accrues on student loans daily. In some cases, it can also capitalize, where it gets added to your principal balance. When capitalization happens, you are basically paying interest on your interest and will owe more money in the long run.
Here's how your student loan balance could increase under different circumstances, and strategies you can use to avoid owing more than you borrowed.
While you’re in school
Interest charges start as soon as your loan is disbursed, so you’ll typically build interest while you’re still in school.
This interest is waived if you have federal subsidized loans. If you have unsubsidized loans or private loans, however, you’re on the hook for any interest accrued during school. This means you can leave school with a higher student loan balance than you started with, even though you weren’t required to make payments while working toward your degree.
To avoid this, consider making interest-only payments on your unsubsidized student loans while you’re still in school. This will decrease the amount you pay toward in the long run.
During a forbearance
A federal student loan forbearance allows you to pause payments for up to 12 months at a time.
Interest accrues on federal student loans during a forbearance. For almost all loan types, including commercially held FFELP loans, unpaid interest will capitalize when you leave a forbearance. (One exception: if you have federal Perkins loans, unpaid interest will never capitalize.) Consider making optional interest-only payments during a forbearance to avoid a growing balance.
Forbearance periods vary for private student loans, but interest typically builds and capitalizes once the forbearance is over.
During a deferment
A student loan deferment is a bit different from a forbearance, but it also allows you to temporarily pause your payments. You must meet a qualifying condition to get a deferment, like losing your job, going back to school, undergoing cancer treatment or serving in the military on active-duty.
During a federal student loan deferment, interest will behave differently based on the type of loan you have:
Unsubsidized loans. Interest will accrue during the deferment period, and it will capitalize after the deferment ends. Consider making optional interest-only payments while you defer unsubsidized loans to avoid a growing student loan balance.
Subsidized loans. Interest will not accrue during the deferment period, nor will it capitalize after the deferment ends.
For private student loans, interest typically builds during a deferment and capitalizes when the period ends.
Federal student loan consolidation could cause your balance to increase.
A consolidation can lengthen the amount of time you’ll have to repay your student loan, which means you’ll pay more interest overall.
Interest will also capitalize. Any unpaid interest on the loans you consolidate will be added to the principal balance of your new consolidation loans, so future interest may accrue on a larger balance.
Under income-driven repayment plans
Your student loan balance can increase under certain income-driven repayment (IDR) plans, which cap your monthly payments at a set percentage of your income and extend your repayment term to as long as 25 years. Once your repayment term ends, remaining debt is forgiven.
When you’re on an IDR plan, payments are applied to fees and interest first, then to the principal. If your monthly payment doesn’t cover all of the interest that accrues each month on certain IDR plans, the leftover unpaid interest could carry over to the next month and increase your student loan balance – and it could even capitalize.
Here’s how each IDR plan treats unpaid interest:
Saving on a Valuable Education (SAVE)
The new IDR plan, called SAVE, is the best option to avoid a ballooning balance. Leftover interest never accrues or capitalizes — for subsidized or unsubsidized loans — so your loan balance won’t increase.
For example, if $50 of interest builds up on your loan each month, but your payment is capped at $30 under the SAVE plan, then the remaining $20 will be erased from your balance and it won’t carry over to the next month as long as you continue to make your required payment.
Pay As You Earn (PAYE)
Under the Pay As You Earn (PAYE) plans, the government will waive any interest not covered by the monthly payment on subsidized loans during a borrower’s first three consecutive years of repayment. For example, after those three years, unpaid leftover interest will start accruing each month.
Borrowers don’t receive this temporary benefit for unsubsidized loans.
Income-Based Repayment (IBR)
Just like PAYE, the Income-Based Repayment (IBR) plan offers a temporary interest waiver — for subsidized loans only — if your payments don’t cover all of the interest that builds each month. This subsidy lasts for up to three consecutive years after you start repayment.
However, there are two unique scenarios under which unpaid interest could capitalize in the IBR plan:
If you leave the IBR plan. IBR is the only IDR plan that capitalizes your interest when you leave it. As of July 1, 2023, you can leave the other three IDR plans with no capitalization penalty.
If you fail to recertify your income by the annual deadline. IBR is the only IDR plan that penalizes you with interest capitalization if you don’t recertify your income by the annual deadline.
Income-Contingent Repayment (ICR)
Under the Income-Contingent Repayment (ICR) plan, any unpaid leftover interest remaining after your monthly payment will carry over. The unpaid interest will continue to accumulate until you pay off your loan or the debt is forgiven.
If you’re enrolled in ICR, unpaid interest will also capitalize annually until the capitalized amount is worth at least 10% of your original principal. This annual capitalization does not occur under the other three IDR plans.