Capitalized interest on your student loans can cost you hundreds or even thousands — here's how to avoid it
By: Business Insider
August 25, 2021 at 11:06 AM EDT
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While student loans can be a worthwhile option to fund your education, the money you pay in interest can quickly add up and make the total cost of your loan far exceed the initial amount you borrowed. Make sure you understand what you're getting into with capitalized interest on your student loans.What is capitalized interest?
Capitalized interest is unpaid interest added onto your loan balance after periods of nonpayment, including forbearance, deferment, and after your grace period. This will increase your overall loan balance, and you'll later pay interest on that higher amount, upping the total cost of your loan.
Here's an example, assuming you take out a $20,000 loan at a 5% interest rate. In this scenario, you have a standard 10-year repayment term, and you are not required to make payments during four years of college and a one-year grace period.
In the following table, we are comparing how much you would pay if you deferred payments for four years of school and the grace period versus if you made interest-only payments during this time.
The difference between deferred payments and interest-only payments over this 10-year term is $1,364. Capitalized interest can get expensive fast, so try to avoid it if at all possible.
You'll also pay less per month once repayment begins if you made interest-only payments while in school and during your grace period, because you're making payments on a smaller loan balance. You'd pay $265 per month after deferred payments, while you'd pay $212 per month after interest-only payments.Interest on federal student loans
The interest on Direct Subsidized Loans will be paid by the government while you're in school and during your six month grace period, so you won't have to worry about interest capitalizing on your loan during with federal forbearance.
However, if you begin paying down the balance on your loan before your grace period is up, you'll still pay less in overall interest. Why? Because your starting loan principal will be lower when you need to start paying interest.
The difference between a 5% interest rate on a $10,000 balance versus on a $5,000 balance might not seem like a lot, but over a 10-year repayment period, you'd pay roughly $1,400 more in interest alone on the $10,000 balance.
When Direct Unsubsidized Loans and Direct PLUS Loans aren't in COVID-19 forbearance, interest will begin to accrue as soon as your loan funds are disbursed, so you may want to start paying it off before your repayment period begins.Interest on private student loans
You may be able to request forbearance from your private lender, but unlike federal loans, interest will likely still accrue while your payments are on hold. Private student loans generally come with higher interest rates than federal student loans.
Private lenders usually offer either three or four repayment plans, which are as follows:
Before you decide to defer your student loan payments until your grace period is up, consider how capitalized interest might substantially increase the cost of your borrowing.Related Content Module: More on Loans