Q: I just received a statement for tax purposes on my private student loans. I am currently in forbearance on the private student loans, and I noticed I had something called “capitalized interest” on my loan statements. What is capitalized interest and why do I have it?
A: If you have read in your student loan terms or have heard your student loan lenders speak about the term “capitalized interest”, you are likely going to want to find out if the lender will capitalize the interest on your student loans, under what terms, and if they do this multiple times throughout the year.
Capitalized interest on student loans can happen for a few reasons, such as using the grace period, deferment, or forbearance options on the student loans. Some student loan lenders will take the interest that accrues on the student loans while you are in college or in a deferment period and then add it to the principal, or the original borrowed amount of the loan (this is capitalization). Usually this only applies to unsubsidized federal student loans and private student loans. What capitalization does, is it increases the amount owed on the principal of the loan, which can increase the monthly payment amount of your student loan after the deferment, forbearance, and/or grace period is over (for private student loans interest will always likely capitalize during deferment or forbearance). Since using a forbearance or deferment can increases the total amount paid on the loan significantly, it is suggested to not utilize these options unless absolutely necessary.
In addition to capitalizing the interest during the deferment, forbearance, and grace periods, there are some student loan lenders out there that will capitalize interest every 3 or 6 months, while others only once a year. For you as the borrower, the least expensive option is going to be a lender that is capitalizing the loan interest only once.