Understanding Capitalized Interest on Student Loans

By Carolyn Desalu · September 06, 2023 · 6 minute read

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Understanding Capitalized Interest on Student Loans

Borrowing money to pay for school comes at a cost, in the form of interest. In certain situations, interest that has accrued may be “capitalized” on the loan. This means that the accrued interest is added to the principal, or the initial amount borrowed. This new value is then used to calculate the amount of interest owed each day.

Interest capitalization can dramatically increase how much a borrower owes over time. Students who have subsidized federal student loans don’t have to worry about interest accruing while they are in school or during their grace period. For other types of federal student loans, including unsubsidized loans and PLUS loans, borrowers are responsible for paying the accrued interest.

Read on for more information about capitalized interest and student loans plus ways that can help reduce the impact of capitalized interest.

How Student Loans Work

There are a variety of student loans and each has specific requirements and terms.

For example, an undergraduate, grad student, or their parents can take out a loan from the government, which is called a federal student loan. Generally, federal student loans have fixed interest rates and offer more flexibility in their repayment plans.

A loan from a private bank or lender is known as a private loan. These financial institutions may offer fixed or variable rates. A fixed rate will stay the same throughout the duration of the loan while a variable rate is pegged to market rates and could fluctuate.

Interest is typically quoted as a percentage, such as 7.00%. When compound interest is factored in, 7.00% can amount to a lot. For example, assuming there were no extra fees, 7.00% interest charged on a $30,000 loan would generate around $11,799 in interest charges over a 10-year repayment term. That’s more than a third of the value of the original loan. To estimate what you could owe in interest on your student loans, take a look at SoFi’s student loan payoff calculator.

💡 Quick Tip: Ready to refinance your student loan? With SoFi’s no-fee loans, you could save thousands.

When Does Interest Accrue?

Interest on federal student loans begins to accrue the day the loans are disbursed, and they accrue interest daily throughout the lifespan of the loan. This is likely the case for many private student loans, but be sure to confirm the terms with the lender before borrowing. Regardless of whether the student loan is federal or private, the promissory note generally includes all pertinent information on the loan.

Depending on the type of loan(s) a borrower has — subsidized or unsubsidized — they may or may not be responsible for paying for the interest charges accrued while they are enrolled in school and during periods of deferment or forbearance.

Immediately after graduation, most federal loans offer a six-month grace period where borrowers aren’t required to make loan payments. The grace period exists so recent graduates have time to find work. Not all loans have grace periods and even if they do, interest may still accrue during the grace period, but a borrower may not be responsible for paying it during this time.

Understanding Interest During Deferment or Forbearance

Students may be able to temporarily halt their student loan payments with programs such as deferment or forbearance due to economic hardship or job loss, but interest may accrue during these periods.

Borrowers with subsidized loans won’t have to pay interest accrued during periods of deferment because the government covers those interest charges. However, the government pays no interest charges on unsubsidized loans during deferment and does not make interest payments on any loan types during periods of forbearance.

It’s important to understand whether or not the interest will be capitalized on the loan before filing for deferment or forbearance. This can help borrowers prepare for what lies ahead.

💡 Quick Tip: When refinancing a student loan, you may shorten or extend the loan term. Shortening your loan term may result in higher monthly payments but significantly less total interest paid. A longer loan term typically results in lower monthly payments but more total interest paid.

What Is Capitalized Interest On A Student Loan?

When accrued interest is unpaid, it is added to the principal value of the loan. This new loan principal becomes the value that is used to calculate the interest. Because the borrower is now paying interest on top of this new, higher loan balance, future payments will also be higher.

When Capitalized Interest Comes Into Play

Capitalized interest can happen on student loans in several scenarios. First, it may happen after a borrower graduates from school or after a grace period, and unpaid interest is added to the balance of the loan. Second, it could happen after periods of student loan forbearance or deferment.

Even though payments are not due during these periods, interest is often calculated and added to the balance of the loan once that period is over. This is the process of capitalization which will likely increase the student loan balance.

Borrowers utilizing income-driven repayment plans may want to pay attention to capitalized interest as well. In these situations, unpaid interest may be capitalized on the loan:

•   If an individual voluntarily leaves the Revised Pay as You Earn, Pay as You Earn, or Income-Based Repayment plan

•   If the borrower does not update their income each year for select income-driven repayment plans

•   If a borrower is repaying their loan using the PAYE or IBR plan and no longer qualifies to make payments based on their income

In general, unpaid interest is added to the principal of a loan during any major change to the status of the student loan.

Ways to Minimize Capitalized Interest

There are a few ways that borrowers can try to minimize capitalized interest. Once interest is capitalized, there is little a borrower can do about it, so the trick is to avoid scenarios where interest is capitalized in the first place.

Making Interest-Only Payments

Consider making interest-only payments while in school, during the loan’s grace period, or during periods of deferment or forbearance. If that isn’t in the cards, try to minimize the amount borrowed.

Applying for Scholarships and Grants

Continue to look for scholarships and grant money while enrolled in school and after receiving your financial aid award. Scholarships and grants are free in the sense that they are not required to be repaid.

Think Carefully Before Taking a Deferment or Forbearance

Graduates should be judicious about taking a deferment or forbearance period, whether this period is immediately following school or arises after a borrower loses their job. While you shouldn’t feel bad about utilizing these programs when needed, it can be a wiser decision to do so only if it’s totally necessary.

If a borrower puts their loans in deferment or forbearance, they can try making interest-only payments. Even if they’re not able to tackle the principal at this time, making interest payments makes it possible to minimize the amount of interest that may ultimately be capitalized on the loan.

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The Takeaway

When the accrued interest on federal student loans is unpaid, it may be added to the principal value of the loan under certain circumstances. This becomes the new principal value of the loan and is used to calculate the interest as it accrues moving forward. This is capitalized interest. In the long term, capitalized interest can make the cost of borrowing more expensive.

Looking to lower your monthly student loan payment? Refinancing may be one way to do it — by extending your loan term, getting a lower interest rate than what you currently have, or both. (Please note that refinancing federal loans makes them ineligible for federal forgiveness and protections. Also, lengthening your loan term may mean paying more in interest over the life of the loan.) SoFi student loan refinancing offers flexible terms that fit your budget.

With SoFi, refinancing is fast, easy, and all online. We offer competitive fixed and variable rates.

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SoFi Student Loan Refinance
If you are a federal student loan borrower, you should consider all of your repayment opportunities including the opportunity to refinance your student loan debt at a lower APR or to extend your term to achieve a lower monthly payment. Please note that once you refinance federal student loans you will no longer be eligible for current or future flexible payment options available to federal loan borrowers, including but not limited to income-based repayment plans or extended repayment plans.

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Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.


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