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Capitalized interest on student loans increases the total amount you have to pay back. It’s unpaid interest that typically gets added to your student loan balance after periods when you don’t make payments — such as during deferment or forbearance.
This interest is something to avoid; otherwise, you’ll repay much more than you originally borrowed.
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How much does capitalized interest cost?
Say you borrow $5,000 each year you’re in school at an interest rate of 5% each year. Over four years of school and a six-month grace period, $2,937 in interest accrues. At repayment, that interest amount will capitalize — get added to your balance — and you’ll owe $22,937.
Going forward, you’ll pay interest on top of that capitalized interest — an extra $31 a month, in this case.
But you can avoid this by paying off the interest before it capitalizes. If you pay the $2,937 in interest before it’s added to your balance, you would owe $20,000. By avoiding capitalization, you would save $802 over the life of the loan, making it easier to pay off your student loans sooner.
What causes interest to capitalize on student loans?
There are several situations in which interest capitalizes.
For federal student loans, capitalization of unpaid interest occurs:
When the grace period ends on an unsubsidized loan.
After a period of forbearance.
After a period of deferment, for unsubsidized loans.
If you leave the Revised Pay as You Earn (REPAYE), Pay as You Earn (PAYE) or Income-Based-Repayment (IBR) plan.
If you don’t recertify your income annually for the REPAYE, PAYE and IBR plans.
If you no longer qualify to make payments based on your income under PAYE or IBR.
If you’re on the Income-Contingent Repayment (ICR) plan, it capitalizes annually.
When you consolidate federal loans.
For private student loans, interest capitalization typically happens in the situations below, but check with your lender to confirm.
At the end of the grace period.
After a period of deferment.
After a period of forbearance.
How to avoid capitalized interest on student loans
You can avoid capitalized interest on student loans in the following ways:
Make interest payments monthly while you're in school. Paying the interest on unsubsidized loans during an in-school deferment will help you avoid capitalization costs, as will avoiding deferment or forbearance altogether. If you have a private loan, opt for a repayment plan that starts with making interest-only payments in school.
Pay off interest before it's added to your balance. By knowing what causes capitalization, you can prevent these costs. For example, make monthly payments during your grace period to eliminate interest before repayment begins. Or pay off interest in a lump sum if you know you'll no longer qualify for an income-driven plan. Payment must happen before your loan's status changes. Contact your student loan lender or servicer to make payments.
Preventing interest from capitalizing can save you hundreds or thousands of dollars.
“Preventing interest from capitalizing can save you hundreds or thousands of dollars.”
For example, say you’re an undergraduate dependent student who borrowed the maximum amount of unsubsidized federal student loans each year from 2014 to 2018. You would owe $27,000, plus $3,276 in capitalized interest. If you paid off accrued interest before it capitalized, your monthly payment would be over $30 lower and you would save $754 over the life of the loan.
Pay off interest during grace period
Don’t pay off any interest; let interest capitalize
Total owed when grace period ends
Use a student loan calculator to find out how much your student loan bill would be if you let interest capitalize.
Key terms in this story
Capitalization: A process that adds unpaid interest to the principal balance of your loan, increasing the amount on which you pay interest going forward. Capitalization generally happens after periods of authorized nonpayment, like deferment and the grace period. You can avoid capitalization by paying at least the interest on your loan each month.
Grace period: A period of authorized nonpayment that generally lasts six months after you’ve graduated, left school or dropped below half-time enrollment. All federal student loans qualify for a grace period, but private lenders may not offer them. You can make payments during the grace period to start paying down the loan and to avoid interest capitalization.
Private student loan: Education funding from banks, credit unions and online lenders instead of the federal government. Private loans are best used to fill funding gaps after maxing out federal loans.