What is capitalized interest on student loans?
Capitalized interest is unpaid interest that is added to your student loan’s principal balance, causing you to pay interest on a larger amount. This process transforms “simple interest” into compound interest, increasing your total debt and monthly payments. You’ll learn when capitalization happens, how much it can cost you, and proven strategies to minimize it.
For families managing college costs, capitalization can quietly increase the total debt burden; for students just starting out, understanding this concept helps you make smarter borrowing decisions from day one. While the term sounds technical, the concept is straightforward: it is the difference between paying interest as you go or letting it pile up and become part of the loan itself.
Context: how capitalized interest fits into your loan
To manage capitalization effectively, it helps to understand where it fits in the lifecycle of a student loan. Most student loans accrue interest daily. This means every day, a small amount of interest is calculated based on your current principal balance and interest rate.
This interest typically sits in a separate “bucket” known as accrued interest. As long as it remains in this bucket, it does not generate new interest itself. However, specific events—known as capitalization triggers—cause the lender to take that accrued interest and move it into the principal balance. This is a one-time event that usually happens when a loan status changes, such as moving from a grace period into repayment.
Once that interest capitalizes, the principal balance grows. From that day forward, daily interest is calculated on this new, higher total. This creates a compounding effect where you begin paying interest on the interest that has already accumulated.
Decision: should you act to prevent capitalization?
Capitalization doesn’t happen every day; it occurs at specific moments. Use this checklist to assess if you are currently at risk and need to take action to save money.
You may face capitalization soon if:
- You are currently in school with unsubsidized federal loans or private loans.
- You have graduated recently and your 6-month grace period is ending (usually 1-3 months away).
- You are currently in a period of deferment or forbearance that is about to expire.
- You are on an income-driven repayment (IDR) plan and are late on your annual income recertification.
- You are in the process of consolidating your federal loans.
If you checked any box above: Yes. You have a window of opportunity to pay off the accrued interest before it is added to your principal. Even a partial payment can help.
If you are in school with Subsidized Loans only: Your risk is low right now because the government pays your interest while you are enrolled. However, you should still plan for when you graduate.
Urgency Level:
- High: Grace period ending next month or IDR recertification due now. See strategies below immediately.
- Medium: Currently in school with unsubsidized loans. You have time to make small payments to keep the balance down.
- Low: In school with subsidized loans only.
For a deeper understanding of your specific loan type, review our guide to federal student loans or compare income-driven repayment options.
When does interest capitalize? Common triggers explained
Understanding exactly when capitalization occurs allows you to plan ahead. For federal student loans, the rules regarding capitalization are set by law. It is important to note that recent regulations have become more favorable to borrowers.
According to StudentAid.gov’s capitalization policy, updated as of July 1, 2023, interest capitalization has been eliminated for several events where it previously occurred. For example, interest no longer capitalizes when you enter repayment under the PAYE or REPAYE (now SAVE) plans, or when you leave those plans.
However, capitalization still occurs during these primary triggers:
| Trigger Event | When It Happens | Can You Avoid It? |
|---|---|---|
| End of Grace Period | When your 6-month grace period ends after leaving school. | Yes, by paying accrued interest before the grace period expires. |
| End of Deferment | When an authorized period of deferment (like unemployment) ends. | Yes, by making interest-only payments during the deferment. |
| End of Forbearance | When a general or mandatory forbearance period concludes. | Yes, by paying interest as it accrues during the forbearance. |
| Loan Consolidation | When you combine multiple federal loans into a single Direct Consolidation Loan. | No, any unpaid interest on the old loans is capitalized into the new loan. |
| Default | When you fail to make payments for an extended period (270 days for most federal loans). | Yes, by staying current or contacting your servicer for options before defaulting. |
Source: StudentAid.gov (Capitalization policy effective as of July 1, 2023)
If you are on an Income-Driven Repayment (IDR) plan, capitalization can also occur if you are removed from the plan for failing to recertify your income on time. This makes staying organized with deadlines financially critical.
Subsidized vs. unsubsidized loans: why it matters for capitalization
The type of federal loan you hold determines your risk level for capitalization. The key difference lies in who is responsible for the interest while the student is in school and during other non-payment periods.
These loans are available to undergraduate students with financial need. According to StudentAid.gov, the U.S. Department of Education pays the interest on these loans while you are in school at least half-time, for the first six months after you leave school (grace period), and during a period of deferment. Because the government covers the interest, there is no interest to capitalize at the end of these periods.
These loans are available to undergraduate and graduate students regardless of financial need. Interest begins accruing from the moment the loan funds are disbursed. If you choose not to pay this interest while in school, it will accumulate and eventually capitalize when your grace period ends.
For example, according to StudentAid.gov, first-year undergraduates can borrow up to $5,500 in unsubsidized loans. At the 2024-2025 fixed interest rate of 6.53% (for disbursements between July 1, 2024, and June 30, 2025), this will accrue approximately $359 in interest during just one year of school. Over four years, this adds up significantly.
| Loan Type | Interest During School | Interest During Grace Period | Capitalization Risk |
|---|---|---|---|
| Direct Subsidized | Paid by Gov’t | Paid by Gov’t | Low |
| Direct Unsubsidized | Accrues Daily | Accrues Daily | High |
| PLUS Loans (Parent & Grad) | Accrues Daily | Accrues Daily | High |
Source: StudentAid.gov (Interest rates and loan terms effective July 1, 2024–June 30, 2025)
Understanding this distinction is vital. If you have unsubsidized loans, you are accumulating debt while you study, even if you aren’t required to make payments yet. For more details on loan types, visit our federal loan guide.
The real cost: how capitalized interest increases what you pay
To understand the financial impact of capitalization, it helps to look at the math with real numbers. Let’s examine a scenario involving a standard undergraduate student loan.
Imagine a student borrows $20,000 in Direct Unsubsidized Loans over the course of a four-year degree. Let’s assume an average interest rate of 6.53% (the 2024-2025 federal rate as of July 1, 2024). The student decides not to make any payments while in school.
While the student is in school for four years, interest accrues daily. By the time they graduate and finish their 6-month grace period, the loan has accumulated approximately $5,212 in unpaid interest.
- Original Principal: $20,000
- Accrued Interest: $5,212
When the grace period ends, that $5,212 is capitalized. It is added to the original $20,000.
- New Principal Balance: $25,212
Now, the student enters a standard 10-year repayment plan. Interest will now be charged on the new balance of $25,212, not the original $20,000.
| Metric | If Interest Was Paid During School | If Interest Capitalizes | Difference |
|---|---|---|---|
| Principal to Repay | $20,000 | $25,212 | +$5,212 |
| Monthly Payment | ~$227 | ~$287 | +$60/month |
| Total Interest Paid (10 Years) | ~$7,276 | ~$9,176 | +$1,900 |
| Total Cost of Loan | $27,276 | $34,388 | +$7,112 |
In this example, failing to pay the interest while in school results in a monthly payment that is $60 higher and costs an extra $1,900 in interest over the life of the loan. The total cost difference is over $7,000 when you combine the capitalized interest plus the new interest charged on it.
Proven strategies to minimize or avoid capitalization
The good news is that capitalization is often preventable. By taking small actions during school or grace periods, you can save significant money later. Here are the most effective strategies.
You don’t have to pay the full principal while studying. Making small monthly payments to cover just the accruing interest keeps your balance from growing. On a $5,500 loan at 6.53% (the 2024-2025 federal rate as of July 1, 2024), this might be as little as $30 per month.
According to Mark Kantrowitz, financial aid expert, “Every dollar you save is a dollar less you have to borrow.” Even if you can’t cover all the interest, paying whatever you can afford reduces the amount that eventually capitalizes.
If you couldn’t pay during school, try to make a lump-sum payment of the accrued interest right before your grace period expires. This prevents that interest from being added to your principal.
If you are on an income-driven plan, set a calendar reminder for your annual recertification. Missing this deadline is a common and avoidable trigger for capitalization.
| Strategy | Who It Helps | Difficulty Level |
|---|---|---|
| In-School Interest Payments | Students with Unsubsidized/Private Loans | Moderate (Requires budget discipline) |
| Lump Sum at Graduation | Recent Graduates | High (Requires available cash) |
| Autopay Enrollment | All Borrowers | Easy (0.25% rate discount reduces accrual) |
Sometimes, capitalization is inevitable, such as when consolidating loans. In these cases, focus on damage control: choose the repayment plan with the lowest monthly payment to manage cash flow, or pay extra toward the principal whenever possible to counteract the balance increase. For more ways to reduce your borrowing needs, explore our FAFSA guide and scholarship resources.
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Federal vs. private loans: different capitalization rules
While federal loan capitalization is regulated by law, private student loans operate differently. It is crucial to read the fine print, as policies vary significantly from lender to lender.
As mentioned, federal loans have specific, limited triggers for capitalization. The government has also recently removed several triggers to protect borrowers. The rules are standardized across all servicers.
Private lenders set their own terms in the promissory note. Capitalization can happen more frequently with private loans.
- Frequency: Some private loans may capitalize interest monthly or quarterly if you are not making payments, rather than just at the end of a grace period.
- Triggers: Common private loan triggers include the end of the in-school period, the end of any forbearance, and sometimes after a certain number of late payments.
According to Betsy Mayotte, student loan expert at The Institute of Student Loan Advisors, “In general, federal loans should be your first stop, but private loans can be appropriate when you’ve maxed out your federal eligibility.” When you do use private loans, understanding their specific capitalization schedule is essential to avoiding surprise balance growth.
If you are considering private options, make sure to check the lender’s policy on when interest is added to the principal. You can learn more in our comprehensive guide to private student loans.
Frequently asked questions about capitalized interest
Yes. When you make payments on your student loan, the portion that goes toward capitalized interest is treated as student loan interest for tax purposes. According to the IRS, you can deduct up to $2,500 in student loan interest annually, subject to income limitations.
Capitalization itself does not directly lower your credit score. However, because it increases your total outstanding balance, it can affect your debt-to-income ratio. A higher balance relative to your original loan amount can be seen as a risk factor by other lenders.
Generally, no. Capitalization is a contractual term of the loan or a federal regulation, so servicers cannot simply waive it. However, you can prevent it by paying the accrued interest before the capitalization trigger event occurs.
They are related but different concepts. Capitalization is the specific event of adding unpaid interest to the principal. Compound interest is the effect that follows, where you earn interest on that new, larger principal balance. Capitalization is what makes student loan interest compound.
Understanding capitalization puts you in control of your student loan costs. By knowing when it happens and how to stop it, you can potentially save thousands of dollars over the life of your loan.
- It Increases Costs: Capitalized interest adds unpaid interest to your principal, meaning you pay interest on interest.
- Know Your Triggers: The most common triggers are the end of your grace period, deferment, or forbearance.
- Loan Type Matters: Subsidized loans protect you from interest accrual during school; unsubsidized loans do not.
- Small Payments Help: Paying even $25 a month while in school can significantly reduce the amount that capitalizes.
- Check Private Terms: Private lenders may capitalize interest more frequently than the federal government.
If you have exhausted your federal options and are considering private loans to cover the gap, it pays to shop around. Comparing rates does not hurt your credit score because lenders use a “soft pull” for pre-qualification. A creditworthy cosigner can also help you secure a lower interest rate, reducing the speed at which interest accrues.
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References and resources
For further verification of the policies and rates mentioned in this article, please consult the following official resources:
- StudentAid.gov: Capitalization Policy – Official definition and policy updates.
- StudentAid.gov: Interest Rates and Fees – Current federal loan interest rates.
- StudentAid.gov: Subsidized and Unsubsidized Loans – Overview of loan types and eligibility.
- Consumer Financial Protection Bureau (CFPB) – Resources for managing student debt.
