What is capitalized interest? | 10.12.10

To begin let’s first delineate the difference between subsidized and unsubsidized Stafford loans.  If you received a subsidized loan for school NO interest will accrue while you are in school, sweet! If however you have an unsubsidized loan than you are not so lucky.  Granted you could elect to make interest only payments if you so choose while in school, but if you don’t that interest will later be added onto your principal amount, and overall will increase your debt.  Let’s take a look how.

So what is capitalized interest exactly?  When the interest is not paid during college, it is accrued and added to the principle balance. Capitalization occurs the day the deferment period is over and the interest accrued over the loan period is added to the original amount of the loan. This additional amount subsequently accrues interest, adding an additional expense to the loan.

Here is an example.

Loan amount: $6,000.

Interest per month: $20

Loan balance after 1 year: $6,240

Loan principal upon capitalization (let’s say after 2.5 years): $6,600

Then that $6,600 loan balance is used as the new benchmark instead of  $6,000.  Now the monthly interest may go up to $21.78.

This was just a very basic visual used to demonstrate the capitalization concept.  Actual balances and interest rate calculations may vary.

Confused about any other terms.  Check out the Student Loan Network Glossary.

Also, find more information on the Difference Between Subsidized and Unsubsidized Loans.


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19 Responses to “What is capitalized interest?”

  1. Mike Raeder says on March 1, 2013 at 6:39 pm:

    I just spoke with my student loan company to see 1) what my qualified interest amount was for 2012 and 2) what my capitalized interest amount was.

    They informed me that:

    1) Actual Interest Paid (amount they reported to IRS for 2012) = $1,112.00
    2) Capitalized interest amount for the loan = $2,114.00

    ———–
    Am I able to simply add 1) + 2) and then take the max $2500 deduction? If so, can I deduct the remaining capitalized balance ($726.00) and apply it to a later tax year?

    Reply To This Comment
    • Student Loan Guru says on March 4, 2013 at 10:59 am:

      Yes, according to IRS Publication 970:

      “Capitalized interest is treated as interest for tax purposes and is deductible as payments of principal are made on the loan. No deduction for capitalized interest is allowed in a year in which no loan payments were made.”

      So assuming you made payments on the loan in 2012, you can add interest paid and capitalized interest to claim the entire deduction.

      See http://www.irs.gov/pub/irs-pdf/p970.pdf for more information on this.

      Reply To This Comment
  2. burke ritchie, new mexico says on August 22, 2012 at 9:48 am:

    A capitalized loan is a usurious loan which should be illegal.

    Reply To This Comment
    • SMSF loans says on December 18, 2012 at 1:03 am:

      Yes it is true stafford loan interest is not capitalized untill the students leaves school.

      Reply To This Comment
  3. Kim Renfro says on July 16, 2012 at 9:20 pm:

    Just received notice that interest of $148.75 is owed. If it is not paid it will be added to the principal balance of the loan (capitalized). Loan owed is $8,547.35 and earns 7% interest. What can I expect?

    Reply To This Comment
  4. kathleen young says on March 25, 2012 at 7:38 am:

    Now that i know my husband had capitalized interest on his loan is there anyway for any of that interest to be exsponged? also, say after the 4000.00 dollars is paid can the rest(10,000.00) be used as all interest on our federal income tax?
    let me explain,4000.00 was the loan 17,000.00 was the amount owed when started paying,they dropped 3,000.00.We have been paying for about five yrs now as a hardship.
    Thanks for any help you can give me.

    Reply To This Comment
    • Student Loan Guru says on March 27, 2012 at 11:31 am:

      Once interest is capitalized, it is becomes part of the principal balance and interest begins to accrue on the new principal amount. There is no way to undo the capitalization of interest if that’s what you’re asking.

      Can you clarify the rest of your question? The only interest you can claim is any interest payments that were made towards the loans (you should receive a form from your loan provider detailing your eligible payments for the past year)

      Reply To This Comment
  5. Nathan Sapp says on March 23, 2012 at 9:02 pm:

    Why do people always think deductions are a good thing on a tax return? If you get a $2000 deduction, that means you paid at least $2000 in interest. When you have a tax deduction of $2000, if you are in the 25% tax bracket you did not have to pay tax on that $2000, meaning you essentially did not have to pay $500 in taxes. Why would it possibly not make sense to pay your loan off? You would be saving $1500 in interest paid for the year if you paid the amount off.

    Reply To This Comment
    • Surra says on January 4, 2013 at 12:04 pm:

      That’s a bit rude, to assume everyone can pay as much as you. People who take out loans do so because they can’t pay hard cash up front, and perhaps they fell on hard times, it’s not the the economy has tanked…Right? It would be hard for you to be any more of a snob.

      Reply To This Comment
      • Erica says on February 6, 2013 at 2:59 pm:

        He is hardly being a snob. He is pointing out why the justification of not paying student loans down because of the tax deduction is a very flawed way of thinking. This year my student loan interest tax deduction got me an extra $200 back in my refund, but I paid nearly $2K in interest…hmmm, not that sweet of a deal is it? I would have rather kept that $2K for myself.

        Unfortunately debt is viewed as normal in society and debt is what causes so many problems for people. It IS possible to go to college without student loan debt, if you make the right choices (i.e. choosing a school you can afford to cash flow, starting off at a community college to save money) and if you work part-time throughout your college career.

        Paying off student loans is one of the best feelings in the world, and you certainly don’t need to be making six figures to do so.

  6. Kati says on December 17, 2011 at 11:42 am:

    BE WARY of how your payments are applied if you have this type of student loan.

    If you pay your scheduled amount each month (exactly on time) and on the SAME day or the day following make an extra payment, the extra payment will go toward principle. (This assumes you are making online payments).

    If you pay by check, you must note on the check that you want the payment to principle only. Again,send it timely.

    I was making extra payments each month added to my scheduled payments thinking this would help pay down the principle. When I had extra money I would simply make an additional payment at different times each month. The loan company first took the monthly interest that had accrued for any days that month after my payment date, and THEN applied the rest to principle. The total amount of the extra payment was never applied to principle. I was shocked! This was an expensive lesson and a decpetive practice.

    Nowhere on their website does it mention “pre-payment” and how it is applied. I was told I had to fax a request to receive the information on pre-payment back in writing. Seriously?

    Reply To This Comment
    • Heather says on December 28, 2011 at 4:57 pm:

      Kati, I’d like to know more about what you’ve learned. What do you mean by pre-payment? Also, you are saying that anything paid beyond your minimum payment will go directly to paying the monthly interest and will not even touch the principle until…the monthly accured interest is paid or is it a collected capitalized interest. I’m trying to understand my loans and my balance has barely moved in 2 years.

      Reply To This Comment
    • Mark says on March 9, 2012 at 10:03 am:

      I just realized the same thing. I looked at my loan history and every time I made extra payments they took the ENTIRE amount and applied it to interest. I am furious. I’m thinking there has to be a way to get this applied back to the principal. After all, it is my money, they should honor my request to apply it to the principal.

      Reply To This Comment
  7. John Kosko says on April 17, 2011 at 8:35 am:

    An issue that need to be addresses here is student loan interest deduction for income tax. We made the mistake of paying off the entire $26K loan all at once wherein $7K of the balance was capitalized interest, but the student loan interest deduction is limited to $2K in any given year. In other words we lost a good part of the interest deduction by paying the loan off all at once. Given that we had the cash to pay off the loan, it probably would have been more prudent to pay it off over a two-year period therebye getting a net $4K deduction.

    Reply To This Comment
    • Josh says on February 16, 2012 at 8:09 am:

      John,

      Isn’t it better to not have the debt rather than not have a tax write-off? A tax write-off is great but it probably won’t benefit you in the long-run as much as not paying the interest on those loans. I’m coming up on graduation and trying to figure out the best way to pay off my loans.

      Reply To This Comment
      • Ryan says on March 14, 2012 at 9:40 am:

        No, because one could be getting stock dividends (and any increase in stock value) with all that dough. Furthermore, no tax on $2000 is a few hundred bucks. Spreading it out over two years would have been the sensible thing to do.

    • Tricia says on February 29, 2012 at 1:50 pm:

      You will only be able to deduct up to $2500 in interests, so really you received close to the max regardless.

      Reply To This Comment
  8. samanthab says on October 15, 2010 at 10:48 am:

    Adrian, good catch. I've corrected the information above and updated the resources. Thank you.

    Reply To This Comment
  9. Adrian Noble says on October 1, 2009 at 12:43 pm:

    On the page “12.11.08 | Federal student loan interest capitalization” it says Stafford loan interest is not capitalized until the student leaves school. Above it says
    it “capitalizes quarterly”.

    They can’t both be right.

    Reply To This Comment

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