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The federal government does not pay the interest on unsubsidized loans during a deferment or forbearance and the interest on subsidized loans during a forbearance. If the borrower does not pay this interest as it accrues, it is capitalized by adding it to the loan balance.
Capitalization affects the compounding of interest. When interest is added to the loan balance, interest may begin being charged on this interest.
Interest Capitalization Frequency
For federal student loans, capitalization usually occurs at the end of the deferment or forbearance period.
For private student loans, capitalization may occur more frequently. In addition to capitalizing interest at the end of the deferment or forbearance period, capitalization may also occur monthly, quarterly or annually. Most, however, capitalize once, at the end of the deferment or forbearance period.
Cost of Interest Capitalization
The loan balance at repayment is typically about one fifth higher due to the impact of interest capitalization and loan fees.
This table shows the impact of interest capitalization on the loan balance at repayment and the total loan payments, assuming a 5% interest rate with no fees and 10-year repayment term. Percentages are compared with the amount originally borrowed.
5% interest, no fees, 10-year term 51-month in-school/grace period |
Subsidized Interest |
Capitalized at Repayment |
Capitalized Monthly |
Increase in Loan Balance at Repayment |
0% |
21% |
24% |
Total Payments vs. Amount Borrowed |
27% |
54% |
57% |
This table shows the results assuming 32 months in an in-school and grace period, the average life of a loan dollar in an in-school and grace period.
5% interest, no fees, 10-year term 32-month in-school/grace period |
Subsidized Interest |
Capitalized at Repayment |
Capitalized Monthly |
Increase in Loan Balance at Repayment |
0% |
13% |
14% |
Total Payments vs. Amount Borrowed |
27% |
44% |
45% |
This table shows the results assuming a 7% interest rate with 4% fees and 51 months in an in-school or grace period.
7% interest, 4% fees, 10-year term 51-month in-school/grace period |
Subsidized Interest |
Capitalized at Repayment |
Capitalized Monthly |
Increase in Loan Balance at Repayment |
4% |
35% |
40% |
Total Payments vs. Amount Borrowed |
45% |
88% |
95% |
As these tables demonstrate, interest capitalization has a much greater impact on the total payments over the life of the loan than on the loan balance when the loan enters repayment.
