The content below is from CommonBond.co, explaining all the need-to-know information for us students taking out loans! We will post each day of the 10 days of Student Loan Boot Camp once a week.
Now that you know the difference between principal and interest, on Day 3 of the CommonBond Student Loan Boot Camp we're going to discuss "capitalized interest."
Day 3: Capitalized Interest
Capitalized interest is interest that has accrued on your student loans during a deferment or forbearance period and is added to your loan balance when repayment begins.
(We will discuss what forbearance and deferment mean on Day 4 of the CommonBond Student Loan Boot Camp.)
After unpaid interest accrues—if, for instance, you deferred all student loan interest payments while in graduate school—the total amount of that unpaid interest is added to your loan principal, or "capitalized." Your interest typically capitalizes when you need to begin repaying your loans so that your loan's interest rate can be applied to this new (and larger) loan principal.
Interest capitalizes following:
A six-month grace period that begins on graduation day
A deferment period for a student loan
A forbearance period for a student loan
If you were paying off your interest while you were still enrolled as a student, no interest would capitalize.
For example, let's say that you've borrowed $30,000 at a fixed rate of 3.19%. If you defer all payments—on interest and otherwise—for two years while you're in grad school and then enter repayment, you'll have $1,914 in accrued interest. The balance on your loan will now go up from $30,000 to $31,914, and your lender will apply your interest rate to this principal to set the payment schedule for the life of the loan. The capitalized interest would cause the monthly interest payment to rise from $292.32 per month to $310.97 per month for a student loan with a 10-year term.
To avoid capitalized interest, you can make student loan payments while you have the opportunity to be in deferment or forbearance, even when you're not required to do so. Making a payment at these times can reduce the amount of unpaid interest on your student loans, which in turn will reduce the amount of interest that will be capitalized.
In Day 4 of the CommonBond Student Loan Boot Camp, we will explain each of the scenarios when student loan interest is most likely to be capitalized.