Interest Capitalization

Capitalization is the addition of unpaid interest to the outstanding principal balance of a loan. When your unpaid interest capitalizes, it increases the outstanding principal amount due on your loan. Then your interest is recalculated based on that higher principal balance, increasing the overall cost of your loan. And depending on your repayment plan, capitalization may also cause your monthly payment amount to increase.

How Interest Is Calculated

A daily interest formula determines the amount of interest that accrues (adds up) on your loan each day. This formula consists of multiplying your loan balance by the number of days since you made your last payment and multiplying that result by the interest rate factor. You can find your interest rate factor by dividing your loan's interest rate by the number of days in the year.

Simple daily interest formula:

Interest Amount = (Outstanding Principal Balance x Interest Rate Factor) x Number of Days Since Last Payment

Situations in Which Accrued Interest Capitalizes

For Loans Held by the U.S. Department of Education:

• When a deferment ends on an unsubsidized loan; or
• If your loans are on an Income-Based Repayment (IBR) plan and you:
  • voluntarily exit to change to a different repayment plan;
  • don’t recertify by your annual due date; or
  • no longer qualify for a reduced payment amount after recertification or recalculation of your plan.

For Loans Held by Banks, Credit Unions, or Other Commercial Lenders:

• When a deferment ends on an unsubsidized loan;
• When a forbearance ends on any loan type (unless it is a special non-capitalizing forbearance);
• When an unsubsidized loan’s six-month grace period ends;
• When a Parent PLUS loan is fully disbursed (when the remaining loan funds are sent to the school); or
• If your loans are on an Income-Based Repayment (IBR) Plan and you:
  • voluntarily exit the plan to change to a different repayment plan;
  • don’t recertify your plan by your annual due date; or
  • no longer qualify for a reduced payment amount after recertification or recalculation of your plan.

How to Avoid Interest Capitalization

If you pay the accrued interest before the situations described above occur, the interest will not be added to your outstanding principal balance, and you’ll save money in the long run. You can log in to your Nelnet.com account to view your accrued interest on the My Loans dashboard card.

Interest Capitalization Example

Say you have a $10,000 Direct Unsubsidized Loan with a 6.8% interest rate. On this loan, the amount of interest that accrues (adds up) each day is $1.86 (see “How Interest Is Calculated” above).

In this example, you’re in a deferment for six months. During the deferment, you do not pay off the interest as it accrues. In this case, the loan will accrue $340 of unpaid interest. At the end of the deferment, the accrued interest of $340 will capitalize (be added to your principal balance).

You’ll then be charged interest on the higher principal balance of $10,340. Based on this increased principal balance, the amount of interest that accrues each day will also increase (to $1.93 per day). This will result in you paying more over the course of repaying your loan balance.