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%. Over four years of school and a six-month grace period, about $2,937 in interest accrues. At repayment, that interest amount will capitalize — get added to your balance — and you’ll owe approximately $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 don’t recertify your income annually for income-based repayment (IBR) plans.
If you no longer qualify to make payments based on your income under Pay As You Earn (PAYE) or IBR.
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 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 reduce 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 IBR. You must make the payment 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.
Use a student loan calculator to find out how much your student loan bill would be if you let interest capitalize.
