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5 Min Read | April 1, 2022

What Is Capitalized Interest?

Capitalized interest is the addition of unpaid interest charges to the balance of a loan. Find out how it can affect your personal finances, especially student loans.

What Is Capitalized Interest?


Capitalized interest is the addition of unpaid interest charges to the balance of a loan (the amount you still have left to pay).

Most commonly, you’ll encounter capitalized interest if you have a student loan with a grace, deferment, or forbearance period.

Capitalized interest also crops up on certain types of mortgages.

Most people are introduced to capitalized interest when discussing student loans or certain mortgages. Understanding what capitalized interest is and what it may mean for your wallet can help you determine whether it is an acceptable trade-off or something you’d rather avoid.

In a nutshell, capitalized interest is the addition of unpaid interest charges to the balance of a loan; it typically arises when loan payments are paused for a period of time.

Suppose you’ve borrowed money from a lender. You get charged interest on the outstanding principal balance over time, say, monthly. That’s called “accruing interest.” When you make a loan payment, a piece of the payment is applied to the accrued interest and a portion goes toward paying down principal, a process called “amortizing a loan.”

But even if you’re not making payments, the interest charges still build up. In some cases, that accumulated accrued interest gets added to your principal balance, a process called capitalizing the interest. At some point, you’ll pay back the principal and the capitalized interest, but the rub is that lenders charge interest on the capitalized interest.

How Does Capitalized Interest Affect Personal Finance?

Two common ways people come across capitalized interest are with student loans and negative amortization mortgage loans. 

Student loans: As soon as you get the borrowed money to pay for education expenses, it begins accruing interest. But loan repayment doesn’t typically begin until after graduation – making prime ground for capitalized interest. In fact, many times there is even a 6- to 9-month grace period after graduation that allows you to further delay starting to make payments. Grace periods, deferments, and forbearances are all situations that can incur capitalized interest.

Negative amortization loans: In a negative amortization loan, the payments are too small to cover the normal interest charges and principal payments that would be required to pay off the loan over time. For example, if you have a negative amortizing mortgage, as time goes by and even though you make payments, your loan balance keeps increasing because the unpaid interest charges are capitalized each month. Negative amortization mortgages can be especially risky if they increase above the value of the underlying home. These loans are not common and, in fact, may even be classified as predatory in some states because of the impact of recurring capitalized interest.

Capitalized Interest Fattens Student Loans

Some of the same student loan features that add financial flexibility for students/parents can end up costing extra money in the end, because of capitalized interest. Deferments – the ability to pause loan payments for up to three years to accommodate things like in-school enrollment, unemployment, military deployment, and financial hardship – can be helpful in the short term, but the accrued interest that builds up during the deferment period can sometimes be capitalized and added to the loan balance.

Similarly, a general forbearance, which pauses loan payments for up to a year if you’re having financial difficulties, almost always results in capitalized interest. Forbearance should not be confused with “forgiveness” – for more on that, read “What is Student Loan Debt Forgiveness?

During 2019, 3.4 million federal loans were in deferment and 2.7 million were in forbearance.1 Since then, a moratorium on student loan payments and capitalized interest has been in effect due to the COVID-19 pandemic and is set to expire on August 31, 2022. Federal loans can be subsidized or unsubsidized; one of the main differences is the government pays the capitalized interest in a subsidized loan and you pay it in an unsubsidized loan. Additionally, private loans can differ in their treatment of capitalized interest.

Since grace, deferment, and forbearance periods are so common, let’s look at an example of how capitalized interest can make your student loan grow larger.2

  • If you borrowed $5,000 per year for four years at an interest rate of 5% and took a six-month grace period after graduating, your principal would be $20,000 and the accrued interest that built up over the 4½ years would be $2,937.
  • That accrued interest is capitalized at the end of the grace period, making the new balance you owe $22,937 – and going forward you will be charged interest on that entire balance. The extra interest on the higher balance is $31 per month, or an extra $802 over the life of the loan.

There are several online calculators that can help you understand the amount of capitalized interest and additional costs you would incur by pausing payments for your student loan. But you can also avoid paying capitalized interest on your loan in one of two ways:

  • Pay off the accrued interest before it capitalizes. Typically, your lender will send you a notice about how much interest will be capitalized at the end of your grace/deferment/forbearance period and the date on which that capitalized interest will be added to your principal balance. By paying it before that trigger date, you can avoid the extra interest costs on the capitalized interest.
  • Make interest-only payments. Another option is to make interest-only payments on your student loan during any period that your loan is accruing interest, like when you are in school. If this is feasible, you will need to contact your lender to make special arrangements for interest-only payments.

The Takeaway

In personal finance, capitalized interest is a term that applies to student loans and negative amortization loans. It involves adding interest charges to a loan’s principal balance. When thinking about personal loans, capitalized interest has the potential to cost you more money in the end. If you can avoid it, you’ll be able to pay off your loans more quickly. And for more about paying off loans, read “How to Get Out of Debt in 2022.”

Kristina Russo

Kristina Russo is a CPA and MBA with over 20 years of business experience in firms of all sizes and across several industries, including media and publishing, entertainment, retail, and manufacturing.


All Credit Intel content is written by freelance authors and commissioned and paid for by American Express. 

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