What Is Capitalized Interest?
5 Min Read | Last updated: April 30, 2025

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Capitalized interest is the addition of unpaid interest charges to a loan balance. Find out how it can affect your finances, especially student loans.
At-A-Glance
- 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 may arise when loan payments are paused for a period of time.1
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.”2 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.”3
But even if you’re not making payments, the interest charges may 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.1
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.4 But loan repayment doesn’t always begin while you are in school – making prime ground for capitalized interest. In fact, there may even be a grace period after you finish school that allows you to further delay starting to make payments. Grace periods, deferments, and forbearances are all situations that may incur capitalized interest.5
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.6
The Impact of Capitalized Interest on 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 deferred 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 if you’re having financial difficulties, almost always results in capitalized interest. Forbearance should not be confused with “forgiveness.”7
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.4 Additionally, private loans may differ in their treatment of capitalized interest.
Interest may accrue on student loans during the duration of the loan and even during the grace period. When this happens, interest is calculated and added to the balance, meaning that it can add up quickly over time.4 For this reason, it’s a good idea to make payments on your student loan during the grace period, or at least pay enough to cover the monthly interest that accrues. Keep in mind that federal student loans may accrue interest differently depending on your payment plan and other factors.5
There are several online calculators that may help you understand the amount of capitalized interest and additional costs you would incur by pausing payments for your student loan.
How to Avoid Paying Capitalized Interest
You may be able to avoid paying capitalized interest on your loan in one of two ways:
Pay off the accrued interest before it capitalizes
By knowing the date on which that capitalized interest will be added to your principal balance, you can take steps to avoid these additional costs. By paying interest off before that date, you may prevent interest from capitalizing.8
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.9
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 may be able to pay off your loans more quickly.
1 “How does interest accrue while I am in school?
2 “What Is Interest? How It Works for Borrowing, Deposits and Investing
3 “What is amortization and how could it affect my auto loan?
4 “Direct Subsidized and Direct Unsubsidized Loans
5 “Interest Rates and Fees for Federal Student Loans
6 “What is negative amortization?
7 “What is student loan deferment?
8 “Interest and Capitalization
9 “What Is Capitalized Interest on Student Loans?
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