Interest Capitalization
Interest capitalization summary:
Interest capitalization is unpaid interest that’s added to your loan balance.
After accrued interest capitalizes, future interest is charged on your new, larger balance, making the overall cost of your loan larger.
If you pause payments on a loan where interest capitalizes and don't pay at least the interest charges, you'll owe more than you originally borrowed.
Interest capitalization definition and meaning
Interest capitalization is the unpaid, accrued interest that’s added to the principal balance of a loan . This typically occurs on loans where interest continues to accrue during a pause in loan payments, like a grace period or deferment period. Capitalized interest increases borrowing costs. Interest capitalization commonly occurs with unsubsidized student loans.
Key concept: Interest capitalization is unpaid interest that’s added to the loan balance. The next time interest is calculated, it’s based on the new, higher balance.
More about interest capitalization
Interest capitalization can happen during periods of nonpayment. Interest may capitalize on a loan that's in a grace period or deferment.
Not all loans have interest that capitalizes. Subsidized federal student loans, for example, have a special feature that lets you avoid interest capitalization. On these loans, you’re allowed to skip payments at certain times, such as when you’re still enrolled in school full-time. Interest still accrues, but the government pays it for you. That way, your loan balance doesn’t grow.
Interest capitalization often occurs with unsubsidized student loans in a grace, deferment, or forbearance period. Interest may capitalize on some kinds of mortgages, as well.
Interest capitalization raises borrowing costs. The loan's principal balance goes up instead of down over time.
You can avoid interest capitalization by paying enough to cover the interest even when payments aren’t required on the loan. If you don't make interest-only payments, your loan balance will continue to grow, and you'll have to pay more in the long run.
Key aspects of interest capitalization
Capitalized interest may have these results:
Increase the loan’s principal balance
Interest is charged on the larger principal balance
Monthly loan payments may increase
Increase the overall cost of borrowing
Interest Capitalization FAQs
How does deferment or forbearance affect loan cost?
Deferment and forbearance allow you to temporarily pause loan payments. If interest continues to accrue while your loans are deferred or in forbearance and you don't make any payments toward the interest or principal during this time, that could leave you with a larger loan balance to repay.
Can missing a payment increase my loan balance?
Yes, your loan will continue to accrue interest on the amount you owe. The more you owe, the more interest you’ll pay. However, if you’re charged a late fee, that won’t increase your loan balance. You owe it, but it’s not part of your loan and you won’t pay interest on it.
Is interest capitalization bad?
Interest capitalization isn’t ideal because it increases the overall cost of a loan. To steer clear of additional borrowing costs, avoiding interest capitalization is best. If you qualify for a grace period or deferment, making interest-only payments during a payment pause could allow you to avoid capitalized interest and additional lending costs.
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