Capitalized Interest: Definition and What It Is
Capitalized interest is accrued interest that has been added to the loan's principal balance and is now folded into the total principal balance owed.
Capitalization commonly occurs at the end of a deferment or forbearance period, at the start of repayment on an unsubsidized loan, and upon certain changes to the repayment plan type. Private lenders set their own capitalization rules, which vary and are spelled out in the promissory note.
Why it Matters
Once interest capitalizes, the loan balance increases, and so does the daily interest charge. A borrower who graduated with $40,000 in unsubsidized federal loans after four years of school may have $6,000 to $8,000 in capitalized interest baked into their opening repayment balance. Although they only borrowed $40,000, they now start repayment on $47,000. During every year of repayment, interest will accrue on the higher figure.
For private loan borrowers who have been in forbearance for a year or more, the capitalized interest can be even more significant relative to the original balance. The repayment options article on Yrefy's blog explains how these figures affect long-term cost across different repayment paths.
Analogy
Capitalized interest is like a snowball rolling downhill. The unpaid interest is the starting snowball. The moment it capitalizes, it sticks to the larger mass of the loan and rolls forward as one piece. From that point on, the whole thing picks up new snow every day. You are no longer paying off the original debt plus a separate interest charge. You are paying off a larger combined amount that grows as a single unit.
