Capitalized interest refers to the addition of accrued interest to the principal balance of a student loan. This means that the interest that has accumulated on the loan while you were in school or during a grace period is added to the original amount you borrowed. This increases the total amount you owe, which in turn leads to higher future interest payments.
How Capitalized Interest Works:
- Accrued Interest: While you are in school or during a grace period, interest accrues on your student loan, even if you are not making payments. This is called accrued interest.
- Capitalization: When the accrued interest is added to the principal balance, it is capitalized. This means that the interest becomes part of the loan's principal balance.
- Higher Payments: After capitalization, the principal balance is higher, leading to higher monthly payments.
When Does Capitalized Interest Occur?
Capitalized interest typically occurs:
- During periods of deferment: When you are not required to make payments on your loan, such as while you are in school or during a grace period, interest accrues. This accrued interest may be capitalized when the deferment period ends.
- During periods of forbearance: Similar to deferment, forbearance allows you to temporarily stop making payments, but interest may still accrue. This accrued interest may be capitalized at the end of the forbearance period.
Examples:
- Scenario 1: You borrow $10,000 for college. Interest accrues on the loan while you are in school. When you graduate and enter the repayment period, the accrued interest is capitalized, adding to the principal balance.
- Scenario 2: You have a $20,000 student loan with $1,000 in accrued interest. You enter a forbearance period for six months. At the end of the forbearance, the $1,000 in accrued interest is capitalized, increasing your principal balance to $21,000.
Impact of Capitalized Interest:
- Increased Loan Cost: Capitalization increases the total cost of your loan by adding to the principal balance, leading to higher interest payments over the life of the loan.
- Longer Repayment Period: A higher principal balance can extend the repayment period, making it take longer to pay off your loan.
Solutions:
- Consider Loan Consolidation: Consolidating your loans into a single loan with a lower interest rate can help reduce the impact of capitalized interest.
- Explore Loan Forgiveness Programs: Some programs, such as Public Service Loan Forgiveness, can forgive a portion of your loan balance, potentially reducing the impact of capitalized interest.
