Understanding Capitalized Interest on Student Loans

By Carolyn Desalu · December 11, 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, called student loan capitalized interest.

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.

What Is Capitalized Interest On A Student Loan?

The simple answer to “What is capitalized interest?” is this: When accrued interest is unpaid, it is sometimes 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.

How Does Interest Capitalization Work on Student Loans?

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 deferment on direct loans and the Federal Family Education Loan (FFEL) Program loans managed by the U.S. Department of Education. Private student loans that are in forbearance may also be subject to capitalized interest.

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 an Income-Driven Repayment plan, does not recertify their income and family size annually, or does not have a partial financial hardship

•   If a deferment period ends

•   If a borrower consolidates their loans

In general, unpaid interest is added to the principal of a loan under an IDR plan under the following circumstances:

•   During times of forbearance or deferment

•   While the borrower is enrolled in school and has an unsubsidized loan

•   The borrower has a grace period.

Can You Avoid Student Loan Interest Capitalization?

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.

How Much Does Capitalized Interest Cost?

The actual cost of capitalized interest varies according to the amount of the principal and interest rate. For instance, if a borrower has $25,000 in student loans with an interest rate of 5%, the capitalized interest could be $3,083. This brings the total amount owed to $23,083.

Note: The monthly payment might be $117 under the SAVE plan, one of the repayment plans offered for federal student loans. The monthly payment can increase if the borrower decides to put the loans in deferment because during these times of non-payment, interest is capitalized.

When Does Interest Accrue?

Interest on federal student loans begins to accrue the day the loans are disbursed, and interest accrues daily through the life 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. 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.

Ways to Minimize Capitalized Interest

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

Graduates should be judicious about taking a deferment 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, 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.

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

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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, which only applies…

•   When a borrower withdraws from an IDR plan.

•   When a borrower does not update their income and family size, or doesn’t have a financial hardship.

•   After deferment or consolidation of student loans.

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.

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.

Checking Your Rates: To check the rates and terms you may qualify for, SoFi conducts a soft credit pull that will not affect your credit score. However, if you choose a product and continue your application, we will request your full credit report from one or more consumer reporting agencies, which is considered a hard credit pull and may affect your credit.

Disclaimer: Many factors affect your credit scores and the interest rates you may receive. SoFi is not a Credit Repair Organization as defined under federal or state law, including the Credit Repair Organizations Act. SoFi does not provide “credit repair” services or advice or assistance regarding “rebuilding” or “improving” your credit record, credit history, or credit rating. For details, see the FTC’s website .

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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