Interest capitalization

Capitalized interest

Interest capitalization is the adding of unpaid interest to a loan's principal, so that from then on interest accrues on the larger figure. It is common on student loans at the end of a deferment, when the interest that accrued while payments were paused is folded into the balance.

What is interest capitalization?

Interest on a loan is charged on the principal. While payments are paused, the interest still accrues, and on most loans it is kept as a separate figure: the principal stays what it was, and the accrued interest sits beside it. Capitalization ends that separation. At the capitalization point, the servicer adds the accrued interest to the principal, and the next month's interest is charged on the sum.

Federal Student Aid lists the end of a deferment on an unsubsidized loan as one of the points where interest capitalizes. On a subsidized federal loan the government pays the interest during a deferment, so there is nothing to add. A private loan capitalizes on whatever schedule its note sets.

Only the interest still unpaid at the capitalization point is added; interest paid before it never enters the principal. Once capitalized, it is principal like any other, and the loan's interest and payment are worked from the new balance.

How interest capitalization works, with numbers

A student loan has a $30,000 principal at 6%. Its interest is $150 a month: 6% of $30,000, divided by 12. The loan goes into a 24-month deferment with no payments. Through the deferment the interest accrues on the unchanged $30,000, so it comes to $3,600 in all.

When the deferment ends the $3,600 is capitalized. The principal is now $33,600, and the next month's interest is 6% of $33,600 divided by 12, or $168, which is $18 a month more than before. Had the $3,600 been paid before the capitalization point, the principal would still be $30,000 and the month's interest $150.

Principal at the start of the deferment: $30,000
Interest a month, 6% ÷ 12: $150
Accrued over 24 months: + $3,600
Principal after capitalization: $33,600
Interest a month after, 6% ÷ 12: $168

Why interest capitalization matters

Capitalization is the point at which unpaid interest starts to cost interest of its own. In the example, the $3,600 adds $18 to every month's interest for as long as it stays in the balance, and a payment that covered the old $150 now covers $18 less of the principal.

It also moves the payoff figures. A level payment worked from $33,600 is larger than one worked from $30,000 over the same term, and a payment that stays the same reaches zero later and pays more interest on the way.

Interest capitalization in Taiga Finance

Taiga Finance has no capitalization event. A debt carries one balance: on a debt whose balance a connected account feeds, it follows the account and carries a “Synced” mark, and on a manual debt it is the “Balance” row under “Details” in the debt's drawer, edited by hand. When a servicer capitalizes interest, the balance rises on the next sync or when it is retyped, and nothing on the page marks the rise as capitalized interest.

What it does show is the effect of the larger balance. Taiga Finance works out a month's interest as the balance times the rate, divided by 12, so a larger balance reads as a larger “Interest this month” in the Debt page's rail. In the payoff plan, a month in which an installment debt's payment does not cover the interest adds the shortfall to the balance, and the planner flags it as “Balance grows before it falls”.

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Key takeaways: Interest capitalization

Interest capitalization adds unpaid interest to a loan's principal, so later interest accrues on the larger figure.
It is common on student loans at the end of a deferment, when the interest that accrued during the pause is folded into the balance.
In the example, $3,600 accrued over a 24-month deferment on a $30,000 loan at 6% raises the principal to $33,600 and the month's interest from $150 to $168.
Taiga Finance has no capitalization event: a debt's balance is fed by a connected account or edited by hand, and a rise in it is not marked as capitalized interest.

Questions about Interest capitalization

What is interest capitalization on a student loan?

The adding of the interest that accrued while payments were paused to the loan's principal, usually at the end of a deferment. From then on interest is charged on the larger balance. A $30,000 loan at 6% that accrues $3,600 over a 24-month deferment becomes a $33,600 loan when that interest capitalizes.

How much does capitalized interest add to a loan?

The accrued interest itself, plus the interest that amount then carries. In the example, capitalizing $3,600 raises the month's interest from $150 to $168, an extra $18 a month for as long as the $3,600 stays in the balance.

Does Taiga Finance track capitalized interest?

No. A debt has one balance, fed by a connected account or edited by hand in the drawer's “Balance” row, and a servicer's capitalization shows up only as that balance rising. Its payoff projection does carry unpaid interest into the balance when an installment debt's payment falls short of a month's interest, and flags the debt as “Balance grows before it falls”.