When changes came around proactively for borrowers suffering from the overwhelming burden of excessive student loan debt; many felt hope for the first time. Changes are continuing to be made in favor of weary borrowers, but as of now there is the realistic Income-Based Repayment (IBR) program and the Pay As You Earn (PAYE) program in effect. The best part about these two programs is that your student loan payments are based on your income, and not the size of the student loan balance.

So What Is The Problem?

Borrowers caught on to the potential pitfall of these approaches. The problem is if your monthly payments are less than the monthly interests, wouldn’t this cause the balance to gradually sneak up? It doesn’t help to look at your loan statements either, because the balance always appears to stay the same. So what is going on?

In The Interest of Interest

We can already assume the government will not look the other way and forget about the interest. The answer is, when your monthly payment is less than the monthly interest, also referred to as a ‘negative amortization’, your balance IS going to grow. The misleading part about this whole deal is that any statements from your lender will not reflect the growing balance.

Okay, there is good news here. The monthly interest isn’t added to your balance until you are finished with your IBR or PAYE. Capitalization is adding the interest to the principle balance. One of the positive perks about IBR and PAYE is that as long as you are enrolled in the program, interest does not capitalize.

No Capitalization is a perk?

Capitalization is a sour concept unless you are on the lender’s team or sporting a hefty annuity policy waiting for that capitalization to double. If interest was to never capitalize, loan balances would grow at much slower rates. Capitalization can grow into such a monster of effectively paying interest on that interest.

Suppose you have a student loan balance of $26,000 and an interest rate of 10%. Suppose you are living right at the poverty line, so your monthly payment is zero dollars. Each year your balance is growing by $10,000 based on the original principal alone. If that interest is capitalized after five years, your new balance will be over $80,000 and fast approaching that $100,000 dollar mark. That means the interest payments alone will now be $8,000 dollars. And this is where they get you. And this is why so many borrowers want to give up. Let’s say, each year you paid $6,000 on that new inflated $80,000 loan only to find out it wasn’t enough, and compound interest shot your student loan right into over a $100,000. You continue for 7 years to pay the outrageous student loan balance with yearly payments between $6,000 and $7,000 dollars—and you Still owe over a $100,000 dollars on that loan.

What happened here? If truth be told, the 7 years of payments would cover the principal of the original amount of loans and then some ‘reasonable’ interests. These loans have compounded interest upon interest. There is no way back from here, and many borrowers are screaming that this is not fair. Some argue if student loans are going to expand this way, then so should social security interest and other programs seeing the downslide. There are many student debt loan horror stories just like this one.

But, as long as you stay on IBR or PAYE your principal balance will never grow and the monthly interest will remain the same. For larger balances and interest rates, this is a huge perk.

Many loan servicers are now being criticized for a lousy job reminding borrowers about the timing and deadlines to re-certify their income to stay on IBR or PAYE. If you fail to certify your yearly income, this will automatically mean that you are no longer enrolled in IBR or PAYE. The moment you are no longer enrolled, the interest capitalizes and your balance grows.

Lenders will tell you that the process can take 2 to 3 months, so submitting your tax records or pay stubs timely isn’t always simple. Most servicers will only send a letter or an email reminding students. These limited reminders do not explain the consequences of failing to re-certify on time.

Earlier this year the Department of Education revealed that over 57% of the people on IBR failed to re-certify on time. With failure to re-certify being such an expensive mistake, people should not be missing this deadline. One mistake that can cost thousands of dollars comes with Income Based Repayment (IBR) or Pay As You Earn (PAYE) re-certifications. You read that correctly. Screwing up your IBR or PAYE re-certification can cost thousands of dollars.

Moral of the story: Do not forget to submit your paperwork.