What Is Capitalized Interest on Student Loans?

Capitalized interest occurs when unpaid interest is added to the principal balance of your student loan. This often happens after grace, deferment, or forbearance periods end. Once interest is capitalized, you’ll make payments on a larger principal amount until the loan is repaid or forgiven. 

While capitalized interest can make student loan repayment more expensive, there are ways to manage or avoid it. Staying informed about when interest capitalizes and taking proactive steps—like paying accrued interest early—can help minimize the long-term cost.

How does capitalized student loan interest work?

When you take out a loan, you must repay the principal—the amount you initially borrowed—and interest. With most loans, your monthly payments cover the interest accrued the prior month plus part of the principal. If you don’t pay all the accrued interest, it may be added to your loan balance. 

With many student loans, your loan payments are deferred for six months after graduating or dropping out of school. Although some student loans, such as subsidized federal student loans, don’t accrue any interest if you’re going to school, in most cases, interest accrues.

When accrued interest capitalizes, it’s added to the principal balance of your loan. When the interest is added to your principal balance, compounding is at work because you’re charged interest on the original principal balance and the interest added to your principal balance. 

Essentially, you’re being charged interest on top of interest. The longer this goes on, the greater your principal balance will grow. 

What causes interest to capitalize on student loans?

Interest capitalization on student loans occurs when unpaid interest is added to the loan’s principal balance. This can happen in several scenarios, and understanding these conditions is essential to figuring out how much your total loan will cost and avoiding interest capitalization, if possible. 

Some common scenarios causing interest to capitalize on student loans are as follows:

1. Grace periods. For many student loans—private and federal—you may not need to make payments for a short time after you graduate or leave school (e.g., six months), commonly referred to as a “grace period.” Once the grace period ends, the accrued interest may be added to your principal balance. 
2. Deferment and forbearance. If you temporarily stop making payments through a deferment or forbearance, interest may continue to accrue. Once your payments are scheduled to resume, the accrued interest may be capitalized to your loan balance. 
3. Income-driven repayment plans (IDRs): For federal student loans under an IDR plan, interest may capitalize when you voluntarily change to another plan, fail to recertify your income as required, or no longer qualify for the plan. 

Interest capitalization commonly occurs after deferment, forbearance, or grace periods, but it is essential to read your loan agreement for the specific terms.

When does interest on a student loan get capitalized on federal loans?

With federal student loans, interest may be capitalized (added to your loan balance) when: 

	Direct Loans & Federal Family Education Loans (FFEL) managed by the U.S. Department of Education	FFEL Loans not managed by the U.S. Department of Education
After unsubsidized loan deferments	✅	✅
If you are repaying your loans under the income-based repayment (IBR) plan and no longer qualify or leave the plan	✅	✅
After a loan forbearance	✖️	✅
After the grace period on an unsubsidized loan	✖️	✅

When does interest on a student loan get capitalized on private loans?

The exact scenarios and timing of when interest will be capitalized for private student loans will vary by lender. For instance, interest might capitalize during or after a loan deferment, grace period, or forbearance. 

Read your loan agreement and inquire with your lender about what will happen with your loan. 

How much does capitalized interest cost?

Ultimately, how much the capitalized interest cost will vary depending on your interest rate, how much interest is capitalized, and the term of your loan. 

For instance, let’s say you have a $15,000 student loan with a 7% interest rate that has been deferred for six months. Your loan agreement says that interest is accrued (built-up) daily. Any unpaid interest is added to the loan’s principal balance (capitalized) at the end of the deferment period. 

The first step is to calculate how much interest is accruing each day. We’ll assume the lender uses a 365-day year to calculate the daily interest rate. So, to calculate the daily rate, we would perform the following calculation: 

7% annual rate divided by 365 days ≈ 0.01918% daily rate

To figure out the amount of interest that’s accrued each day, we multiply the principal balance by the daily interest rate: 

$15,000 principal balance times 0.01918% daily interest rate = $2.88 daily interest

Now that we know how much interest will accrue each day, we can figure out the total interest that will accrue during the six-month deferral period, which we’ll assume equals 180 days. We’ll multiply the daily interest accrual by the deferral period to calculate the total accrued interest:

$2.88 daily interest times 180-day deferral period = $517.81 total accrued interest

At the end of the deferral period, the $517.81 in accrued interest will be capitalized, meaning it’s added to our original loan balance. Once this is done, the new principal balance of our loan will be as follows: 

$15,000 original balance plus $517.81 capitalized interest = $15,517.81 new balance

So far, not paying the accrued interest has increased our loan balance by $517.81. However, now that the accrued interest has been added to our principal balance, we’ll also be charged interest on top of the $517.81 in accrued interest.

To demonstrate how this works, let’s look at the total interest we would pay on the original $15,000.00 principal balance versus the revised $15,517.81 principal balance, assuming we’re going to make payments for 10 years: 

	Original principal balance	Principal balance with capitalized interest
Student loan amount	$15,000.00	$15,517.81
Annual interest rate	7%	7%
Repayment term	10 years	10 years
Monthly payment	$174.16	$180.17
Total interest during the 10-year loan term	$5,899.53 (b)	$6,103.18 (a)
Extra interest charges	n/a	$203.65 (*)

a – b = extra interest charges, so $6,106.18 – $5,899.53 = $203.65

As shown in the table above, if the interest is capitalized to the loan’s principal balance, the student loan will cost you about $204 more over the 10-year term because you’re paying interest on top of interest—the concept of compounding.

Capitalized interest has the potential to substantially increase the overall cost of your student loan. When unpaid interest is added to your principal balance, you’re essentially paying interest on a larger amount, leading to higher monthly payments and more interest accrued over time.

Understanding how and when interest capitalizes—such as after deferment periods, grace periods, or under certain repayment plans—is crucial. By staying informed and, if possible, making interest payments before they capitalize, you can minimize extra costs and manage your loan more effectively.

How can I check if my interest has capitalized?

The best way to check if your interest has capitalized is by logging into your lender’s online portal and reviewing your account balance. When interest is capitalized, you should see an increase in your loan’s principal balance.

Be sure to monitor changes in your loan balance closely, especially at the end of a grace period, deferment, or forbearance. Your lender may also notify you when interest is capitalized, so look for these notifications.

Additionally, you can review your loan statements, which typically include details about your principal balance, payments, interest accruals, and interest rates. These statements will provide helpful insights into whether interest has been added to your principal.

If you have any questions, contact your lender directly. They can explain how you’ll be notified when interest is capitalized and help you check the total amount of interest you’ve accrued on your loan.

How to avoid capitalized interest on student loans

There are a few ways you can avoid having interest capitalized on your student loans or minimize the effects:

1. Pay all accrued interest before it’s capitalized.
2. Choose a student loan that doesn’t accrue interest while you’re in school.
3. Select a repayment plan where interest isn’t capitalized.
4. Understand your loan terms.
5. Refinance or consolidate your loans. 

1. Pay all accrued interest before it’s capitalized

Interest commonly accrues during grace periods, deferral, or forbearance periods. To avoid having the accrued interest added to your principal balance (and then having to pay interest on top of interest), it’s a good idea to pay off any accrued interest before these periods end. 

Even small payments during grace, deferment, or forbearance periods may help reduce the cost of your loan by minimizing capitalized interest.

If your cash flow allows you to make any additional payments during interest-accruing periods—even small amounts—it can lead to significant savings over the long term. It prevents this additional interest from accruing on your loan and then compounding over the years with additional interest—basically, interest on interest. 

Making interest-only or flat payments while you’re in school may help, but typically not as much as most federal-based programs because they usually do not require interest repayment until after you have finished your education.

Rand Millwood, CFP®

2. Choose a student loan that doesn’t accrue interest while in school

Federal subsidized loans don’t accrue interest while you’re enrolled at least half-time. This means there’s no interest accumulating while you’re in school and, therefore, no interest to capitalize when repayment begins. 

If you’re eligible, taking out a subsidized loan can save you money by eliminating interest accrual while in school.

3. Select a repayment plan where interest isn’t capitalized

Income-driven repayment (IDR) plans often allow for reduced payments based on your income. However, unpaid interest may capitalize on an IDR if you leave the plan or no longer qualify. 

To avoid this, choose a repayment plan where interest won’t capitalize as long as you stay enrolled and qualify. Maintaining eligibility for your chosen repayment plan is essential to avoid unexpected interest capitalization.

4. Understand your loan terms

Review your loan agreement to understand when and how interest will capitalize. Some loans have specific triggers, such as after deferment or at the end of grace periods. Knowing these triggers allows you to plan and take action, like making interest payments during grace periods or deferrals. 

If you have questions, don’t hesitate to contact your loan servicer for clarification.

5. Refinance or consolidate your loans

Refinancing or consolidating your student loans could potentially offer a lower interest rate or different repayment plan, which may help reduce the overall interest accrued and capitalized. 

It’s important to note that if interest has already accrued, you’ll still be responsible for paying it. However, securing a lower rate or switching to a new repayment plan can minimize the amount of future interest that accrues or capitalizes, potentially saving you money.

Be sure to carefully weigh the benefits and drawbacks before pursuing student loan refinancing or consolidation, especially for federal loans, as you may lose access to certain benefits like loan forgiveness.

Is there forgiveness for capitalized interest on student loans?

Once interest has been capitalized on a student loan, it becomes part of your principal balance. If you qualify for federal student loan forgiveness, the forgiven amount includes both the original principal and any capitalized interest. 

Tip

Capitalized interest is treated the same as your original principal balance when it comes to federal student loan forgiveness. 

For instance, if you’re on an income-driven repayment (IDR) plan and have remaining loan balances after the required repayment term (usually 20 or 25 years), any outstanding balance— including capitalized interest—may be forgiven. 

The same is true if you qualify for federal Public Service Loan Forgiveness (PSLF) after making 120 qualifying payments while working for a qualifying employer. Both the principal and any capitalized interest would be eligible for forgiveness.

However, it’s important to note that capitalized interest is not separately forgiven. Any interest that has been capitalized will need to be repaid unless you qualify for loan forgiveness of some or all of your student loan balance. 

Until then, it continues to accrue interest, making it essential to manage capitalized interest as part of your repayment strategy.

FAQ

Is capitalized interest bad?

Capitalized interest can be seen as negative because it increases the total balance of your loan. When unpaid interest is added to your loan’s principal, future interest accrues on a larger amount, which means you end up paying interest on the interest. This can make it harder to pay off the loan in the long run, increasing the overall cost.

Is capitalized interest tax deductible?

Yes, capitalized interest on student loans is typically tax deductible. If you meet certain income thresholds, the IRS allows you to deduct student loan interest, including capitalized interest, up to $2,500 annually. This deduction is available whether you itemize or take the standard deduction.

How do I get rid of capitalized interest on student loans?

You’ll need to make payments that cover both the interest and principal to get rid of capitalized interest on student loans. In some cases, you may be able to avoid interest capitalization by making interest payments while your loan is in deferment or forbearance. Another option could be to refinance or consolidate your student loans.

Does interest capitalize on deferred student loans?

Yes, interest generally capitalizes on deferred student loans if you don’t pay the interest that accrues during the deferment period. When your deferment ends, any unpaid interest may be added to the principal balance, causing future interest to accrue on a higher amount.

What does accrued interest mean and does it capitalize?

Accrued interest refers to the interest that accumulates on a loan over time but has not yet been paid. Whether it capitalizes depends on the loan terms. If you don’t pay accrued interest when due, such as during periods of deferment, forbearance, or income-driven repayment plans, it might capitalize—meaning it gets added to the principal balance, increasing your overall loan amount.

Does interest capitalize on student loans in forbearance?

Yes, interest typically capitalizes on student loans in forbearance. Interest continues to accrue during forbearance, and if you don’t pay it off, it will be added to your principal when the forbearance period ends, leading to a higher total loan balance.