Student loans are expensive enough — the last thing you want to do is pay more than you have to. Unfortunately, capitalized interest on student loans can expand your debt before you’ve even realized what’s happened.
But if you understand what causes capitalized interest, you can take steps to prevent it. Read on to learn how capitalized interest on student loans works, along with what you can do to avoid paying too much on your student loans.
What is capitalized interest on student loans?
For all types of debt, including student loans, capitalized interest happens when some of the interest you owe gets added onto your principal balance.
Let’s say you borrowed $25,000 at the start of college, and your loan had a 5.5% rate. If you spend four years in deferment, making no payment on your student debt, your loan will quietly accumulate $6,189 in interest.
Once you graduate and your grace period ends, that $6,189 gets added to your principal amount. Now instead of owing $25,000, you’re on the hook for $31,189.
Not only does capitalized interest on student loans increase your debt, but it also means you end up paying even more interest. Because your principal and accrued interest are now combined, you essentially end up paying interest on your unpaid interest.
Note that borrowers with subsidized loans don’t have to worry about this particular issue, since the federal government covers your interest payments while you’re in school. But if you have unsubsidized loans or private student loans, interest will start accruing from the moment you get the funds.
Needless to say, you’ll want to avoid capitalized interest on your student loans as much as possible so that your college debt doesn’t end up becoming more expensive than it needs to be.
Events that trigger student loan interest capitalization
You don’t have to worry about capitalized interest on your student loans all the time. A capitalization event only happens in a few specific instances.
Here are the most common events that result in capitalized interest on student loans:
- Your grace period ends, and your loan enters repayment.
- Your period of forbearance or deferment ends, and monthly payments resume.
- Your loan comes out of default, and you resume repayment.
- You leave the PAYE, REPAYE or income-based repayment plan or forget to recertify your eligibility each year.
- You’re on income-contingent repayment, so your interest gets capitalized annually.
- You consolidate your federal student loans.
As you can see, some of these events are tough to avoid — you can’t help that your grace period will end and your loan will enter repayment, for example. But even if you aren’t able do much about it, it’s important to understand what’s going on with your loan so you don’t underestimate how much you have to pay back.
6 ways you can avoid paying too much on interest
Although you might not be able to entirely avoid capitalized interest on student loans, there are steps you can take to reduce the number of times it occurs. With these steps, you could lower the amount you pay in student loan interest overall.
1. Pay the interest while you’re still in school
Unless you only have subsidized loans, interest will accrue on your student debt the entire time you’re in college. If you can afford it, pay the interest while you’re a student.
Covering the interest won’t pay down your principal, but it will mean you don’t face a larger balance after you graduate.
2. Make interest-only payments during forbearance or deferment
If you go back to school or run into financial hardship, you might pause your payments through deferment or forbearance. But in most cases, interest will keep growing during this time, and it will get capitalized onto your balance when your period of paused payments ends.
By making interest-only payments during deferment or forbearance, you can prevent your debt from growing.
3. Avoid changing plans more often than you need to
Since changing repayment plans frequently leads to capitalized interest on student loans, avoid changing your plan more often than you need to. The government offers a variety of plans for federal student loans, including the standard 10-year plan, graduated repayment and various income-driven plans.
Learn about your options before you graduate, and weigh all the pros and cons before making changes to your loans. Although an income-driven plan might bring financial relief, for example, you also want to be careful about triggering interest capitalization more than is necessary.
4. Stay on top of your income-driven plan paperwork every year
Income-driven plans, such as REPAYE and IBR, adjust your monthly payments along with your income. In most cases, you’re only eligible for one of these plans if your adjusted payment would be less than what you’d pay on the standard 10-year plan with fixed payments.
Because of this, you have to recertify your eligibility each and every year to stay on an income-driven plan. If you forget, you could get kicked off, meaning your payment will increase, and interest will get capitalized on your student loans.
These events could cause major stress, so avoid them by staying on top of your student loan paperwork every year.
5. Throw extra payments at your student loans
If you can find room in your budget, consider making extra payments toward your student loans. With extra payments, you can pay down your principal and interest even faster.
As you cut down the principal, your smaller loan will accrue less interest, allowing you to speed up repayment even more.
You can make extra payments toward your loans at any time without penalty. That said, you might want to call your loan servicer to ensure it’s applying your extra payment correctly.
6. Refinance your student loans for a lower interest rate
Finally, refinancing student loans is a great way to restructure your debt and potentially snag a lower interest rate on your loans. When you refinance, you give one or more of your loans to a private lender, who then issues you a single new loan in their place.
Depending on your (or your cosigner’s) credit and income, you could qualify for a much lower rate on your student loans. As a result, you’ll pay less interest over time if you keep the same loan terms as your original loan, and perhaps even be able to pay your loan back faster.
And if capitalization does occur, you won’t have to deal with as much interest as you would have if you’d stuck with the higher rates.
That said, refinancing also means you’ll lose access to certain federal programs and protections. If you’re relying on an income-driven plan or are working toward Public Service Loan Forgiveness, for instance, refinancing wouldn’t be the right move for you.
But if you don’t need federal student loan benefits, refinancing could be a strategic way to change your repayment plan and hopefully save money on interest.
Get ahead of interest before it grows out of control
Student loans can be a useful tool for covering the costs of higher education. But if you borrow too much or get saddled with high interest rates, your loans could quickly become a heavy burden.
Understanding how capitalized interest works, and making moves to prevent it, can give you more control over your loans and avoid you paying more than you have to. For instance, making interest-only payments while you’re a student (maybe by working a part-time job) could help keep your debt from ballooning.
Interested in refinancing student loans?Here are the top 6 lenders of 2019!
|Lender||Variable APR||Eligible Degrees|
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1 Important Disclosures for SoFi.
2 Important Disclosures for Earnest.
To qualify, you must be a U.S. citizen or possess a 10-year (non-conditional) Permanent Resident Card, reside in a state Earnest lends in, and satisfy our minimum eligibility criteria. You may find more information on loan eligibility here: https://www.earnest.com/eligibility. Not all applicants will be approved for a loan, and not all applicants will qualify for the lowest rate. Approval and interest rate depend on the review of a complete application.
Earnest fixed rate loan rates range from 3.89% APR (with Auto Pay) to 7.89% APR (with Auto Pay). Variable rate loan rates range from 2.54% APR (with Auto Pay) to 7.27% APR (with Auto Pay). For variable rate loans, although the interest rate will vary after you are approved, the interest rate will never exceed 8.95% for loan terms 10 years or less. For loan terms of 10 years to 15 years, the interest rate will never exceed 9.95%. For loan terms over 15 years, the interest rate will never exceed 11.95% (the maximum rates for these loans). Earnest variable interest rate loans are based on a publicly available index, the one month London Interbank Offered Rate (LIBOR). Your rate will be calculated each month by adding a margin between 1.82% and 5.50% to the one month LIBOR. The rate will not increase more than once per month. Earnest rate ranges are current as of March 18, 2019, and are subject to change based on market conditions and borrower eligibility.
Auto Pay discount: If you make monthly principal and interest payments by an automatic, monthly deduction from a savings or checking account, your rate will be reduced by one quarter of one percent (0.25%) for so long as you continue to make automatic, electronic monthly payments. This benefit is suspended during periods of deferment and forbearance.
The information provided on this page is updated as of 0318/2019. Earnest reserves the right to change, pause, or terminate product offerings at any time without notice. Earnest loans are originated by Earnest Operations LLC. California Finance Lender License 6054788. NMLS # 1204917. Earnest Operations LLC is located at 302 2nd Street, Suite 401N, San Francisco, CA 94107. Terms and Conditions apply. Visit https://www.earnest.com/terms-of-service, email us at email@example.com, or call 888-601-2801 for more information on ourstudent loan refinance product.
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3 Important Disclosures for Laurel Road.
Laurel Road Disclosures
However, if the borrower chooses to make monthly payments automatically by electronic funds transfer (EFT) from a bank account, the fixed rate will decrease by 0.25%, and will increase back up to the regular fixed interest rate described in the preceding paragraph if the borrower stops making (or we stop accepting) monthly payments automatically by EFT from the designated borrower’s bank account.
However, if the borrower chooses to make monthly payments automatically by electronic funds transfer (EFT) from a bank account, the variable rate will decrease by 0.25%, and will increase back up to the regular variable interest rate described in the preceding paragraph if the borrower stops making (or we stop accepting) monthly payments automatically by EFT from the designated borrower’s bank account.
4 Important Disclosures for LendKey.
Refinancing via LendKey.com is only available for applicants with qualified private education loans from an eligible institution. Loans that were used for exam preparation classes, including, but not limited to, loans for LSAT, MCAT, GMAT, and GRE preparation, are not eligible for refinancing with a lender via LendKey.com. If you currently have any of these exam preparation loans, you should not include them in an application to refinance your student loans on this website. Applicants must be either U.S. citizens or Permanent Residents in an eligible state to qualify for a loan. Certain membership requirements (including the opening of a share account and any applicable association fees in connection with membership) may apply in the event that an applicant wishes to accept a loan offer from a credit union lender. Lenders participating on LendKey.com reserve the right to modify or discontinue the products, terms, and benefits offered on this website at any time without notice. LendKey Technologies, Inc. is not affiliated with, nor does it endorse, any educational institution.
5 Important Disclosures for CommonBond.
Offered terms are subject to change. Loans are offered by CommonBond Lending, LLC (NMLS # 1175900). If you are approved for a loan, the interest rate offered will depend on your credit profile, your application, the loan term selected and will be within the ranges of rates shown.
All Annual Percentage Rates (APRs) displayed assume borrowers enroll in auto pay and account for the 0.25% reduction in interest rate. All variable rates are based on a 1-month LIBOR assumption of 2.5% effective February 10, 2019.
6 Important Disclosures for Citizens Bank.
Citizens Bank Disclosures
|2.54% – 7.12%3||Undergrad & Graduate|
|2.54% – 7.27%1||Undergrad & Graduate|
|2.67% – 8.96%4||Undergrad & Graduate|
|3.23% – 6.65%2||Undergrad & Graduate|
|2.69% – 7.43%5||Undergrad & Graduate|
|2.98% – 9.72%6||Undergrad & Graduate|