When Does Student Loan Interest Capitalize?
Understand the specific conditions and moments when student loan interest capitalizes, adding to your principal balance and increasing what you owe.
Student loan interest is the fee borrowers pay to a lender. This cost is calculated as a percentage of the loan’s outstanding principal balance and accrues daily. While in school or during certain periods, interest may continue to accumulate on your loan even if payments are not required. Your interest rate is detailed in your disclosure documents.
What Interest Capitalization Means
Interest capitalization occurs when unpaid, accrued interest is added to the principal balance of a student loan. This process increases the total amount owed, as future interest calculations are then based on this new, higher principal amount. This can lead to a larger overall repayment amount and potentially higher monthly payments over the life of the loan. For example, if $4,050 in unpaid interest is capitalized on a $30,000 loan, the new principal becomes $34,050, and interest will be calculated on this increased sum.
Specific Events Leading to Capitalization
Several specific events can trigger interest capitalization for federal student loans. One common instance is when an unsubsidized loan enters repayment after a grace period. Unsubsidized loans accrue interest while a borrower is in school and during the grace period, and this accumulated interest is added to the principal balance at the start of repayment. Grace periods last six months after leaving school or dropping below half-time enrollment.
Capitalization occurs after periods of deferment or forbearance. For unsubsidized loans, interest that accrues during a deferment period will capitalize when the deferment ends. For both subsidized and unsubsidized loans, interest accrued during a forbearance period will capitalize once the forbearance concludes. While payments are suspended during these periods, interest continues to accumulate, and if unpaid, it is added to the principal.
Capitalization can happen when a borrower exits income-driven repayment (IDR) plans. This includes instances where a borrower voluntarily leaves an IDR plan, fails to complete the required annual income recertification, or no longer qualifies due to increased income. Under some IDR plans, monthly payments might not cover all the accruing interest, leading to unpaid interest that capitalizes if the borrower leaves the plan.
Federal vs. Private Loan Capitalization
The rules governing interest capitalization differ between federal and private student loans. Federal student loan capitalization events are standardized and regulated by federal policy. These events align with specific circumstances like the end of grace periods, deferment, forbearance, or changes in income-driven repayment plans. This provides predictability regarding when capitalization will occur for federal loan borrowers.
In contrast, private student loan capitalization rules vary depending on the lender and the loan agreement. Private lenders are not bound by the same federal regulations regarding when interest capitalizes. Borrowers with private loans must review their loan’s promissory note or contract to understand the terms for interest capitalization. Common triggers for private loans mirror federal loans, such as the end of a grace period or a period of deferment or forbearance, but the specifics can differ.