Capitalized Interest

Interest "capitalization" happens when unpaid interest on your loan is added to your principal balance. From that moment on, you owe interest on the (now-larger) principal — interest on interest. It's one of the main reasons federal student loan balances grow over time.

When capitalization happens

Federal student loan interest can capitalize at several specific events:

• The end of a deferment period (on Unsubsidized loans)
• The end of a forbearance period
• The end of your grace period after leaving school
• When you change repayment plans (sometimes)
• When you consolidate your loans

Why it matters

Suppose you have $30,000 in Unsubsidized loans at 6%. After 12 months in deferment, about $1,800 in interest has accrued. If that $1,800 capitalizes, your new principal is $31,800 — and from then on, the 6% rate is applied to that larger number. Over the life of the loan, capitalization can add thousands of dollars to what you ultimately pay.

How to avoid it

The simplest way to avoid capitalization is to pay the interest as it accrues, even if you're in deferment or forbearance. Most servicers allow interest-only payments without affecting your repayment status.

How SAVE protects you

The SAVE Plan includes a unique provision: if your monthly payment doesn't cover all the interest that accrues, the government waives the difference. This means your balance won't grow under SAVE even if your payment is $0 — a major change from older IDR plans.