Understanding Interest Rates, Fees and Interest Capitalization - Interest Capitalization Tab
Interest capitalization occurs any time accrued and unpaid interest and loan fees are added to the outstanding principal balance of a loan. The more frequently a lender adds the interest to the principal loan balance, the more interest a borrower will pay.
Depending on the terms of your loan, capitalization may occur throughout repayment or as result of the following:
- once, prior to repayment;
- after periods of deferment and/or forbearance;
- on a regular schedule, such as annually.
More Capitalization = More Expense
The more the loan capitalizes the more expensive the loan will be.
You need to keep this in mind if, for example, you decide to defer making interest payments on an unsubsidized Direct loan or a private loan while you are in school. The interest that has accrued during the deferment period will be added to the loan principal - capitalized - when the loan goes into repayment. This will make the total amount owed larger.
The chart below illustrates the difference between paying interest while in school and accruing the interest and having it capitalize once at repayment. The figures are based on a $10,000 loan, 6.8 percent interest rate and 10-year repayment period.
|Interest Capitalization Example|
|Paying Interest while in School||Capitalizing Interest - Full Deferment|
|Total Amount Financed:||$10,000.00||Total Amount Financed:||$10,000.00|
|Your Interest Only Monthly Payments:||$56.67||Your Interest-Only Payment||$0|
|Your Total Interest During Deferment:||$3,343.33||Your Total Capitalized Interest||$3,343.33|
|Your Monthly Payment During Repayment:||$115.08||Your Monthly Payments||$153.56|
|Total Cost of Loan:||$17,152.97||Total Cost of Loan:||$18,426.66|
Learn more about the effect of interest capitalization by using the Interest Capitaization Estimator.