Table of Contents

    What Is Capitalized Interest On Student Loans?

    Capitalized Interest On Student Loans

    Capitalized interest on student loans expands the overall debt that has to eventually be repaid. It refers to the unpaid interest that gets included with the total principal amount of the student loan in the event you fail to make payments. 

    In simple words, the principal loan balance starts increasing due to the delayed payment during the forbearance or deferment period. Accordingly, you should try avoiding this additional interest or end up paying more than you initially borrowed.

    What Causes This

    The reasons behind inclusion of interest in the principal balance are multifold. Federal student loan interest capitalization often occurs when interest is unpaid after:

    • The grace period has ended. 
    • The deferment period has ended in case of an unsubsidized loan.
    • As soon as the grace period concludes on the unsubsidized loan. 
    • If your annual income is not recertified for the Income-Based-Repayment (IBR), Pay as You Earn (PAYE), and Revised Pay as You Earn REPAYE plans
    • If you are no longer eligible to pay the debt based on the earnings under the plans of IBR or PAYE. 
    • If you are following the Income-Contingent Repayment or ICR plan, the interest automatically capitalizes yearly.    
    • Upon leaving the IBR, REPAYE, and PAYE plan.

    The reasons for private student loan interest capitalization are somewhat similar to the federal one, but not as complex. The below-mentioned conditions are more likely to see the unpaid interest rate added to the principal amount. Still, make sure to cross-check these requirements with your lender.  

    • After the deferment period. 
    • When the grace period is closed down.
    • At the end of the forbearance period.

    What Are The Costs?

    The cost of the capitalized interest can depend on the exact loan amount and the due payment of its interest balance. For instance, imagine if your total principal amount outstanding is $10,000 at a yearly interest rate of 7%. 

    After a grace period of 9 months, the total interest that accrued since your last payment is $513.00. When you will continue paying it back, the total amount of unpaid interest will be added to the principal amount.

    Moreover, after the principal is expanded, you have to pay the interest based on the enlarged amount, which will undoubtedly add to the total loan cost. However, you can avoid paying that extra amount and halt the capitalization of the interest. All you need to do is pay the $513.00 amount before it is included in the principal balance. 

    Ways To Avoid Capitalized Interest

    Finding ways to avoid capitalized interest is better than paying the extra amount resulting from capitalization. Use the following processes to avoid capitalized interest on your student loan.

    • Clear the due debt before it is included in the principal amount - The problem can be solved if you choose to clear the monthly due at the grace period to terminate the interest before the beginning of the repayment. Apart from that, you can also clear the interest by a lump sum payment. 
    • Pay the monthly interest when in school - At the time of the in-school deferment, choose to clear the interest amount on the unsubsidized loan. It will assist you with preventing interest c capitalization. If you have private loans, the best option is to choose repayment that begins with paying the interest accruing while in school.

    How Interest Capitalizes In Various Cases

    Here are some common aspects that act on increasing the interest amount in several cases:

    • Upon leaving school - With both private and federal student loans, you receive the option of making a partial payment or halt the loan payment for six months after finishing school. For a loan of $27,000, the due interest will be capitalized to $3,511 in six months, which will make your overall loan balance $30,511. 
    • When you’re approved for payment relief - Being temporarily granted relief can also increase the due interest amount. For example, imagine you decide to attend graduate school instead of working after the grace period. You already owed a principal balance of $30,511 due to deferral. If you withhold payment, it will create an additional unpaid interest which will be capitalized.
    • When you sign for an income-driven plan - Upon enrolling in this plan, unpaid interest rate can pile up if your monthly payment is not enough to cover the total amount due. It can also mount if you are not eligible for IBR and PAYE plans or you leave the PAYE, IBR, REPAYE plans willingly. 
    • When you consolidate loans - When you opt for combining multiple federal loans into a direct consolidation loan, the additional interest rate will add to the original loan amount. 

    Bottom Line

    The thing you should realize is you cannot run away from the outstanding debt balance. Delaying interest payments will do nothing but make your burden even heavier. Therefore, you have to take every step available to avoid capitalized interest on your original loan amount.