Capitalization refers to the addition of unpaid interest to the principal of a loan. After interest is capitalized, it also begins generating interest, so the total amount of interest you pay increases.
There are several circumstances in which unpaid interest is capitalized:
- When you finish school and enter repayment.
- When you perform a Direct Loan Consolidation.
- At the conclusion of grace, forbearance, and deferment periods.
- If you voluntarily leave or change IDR plans.
- If you fail to re-certify your income for an IDR plan.
Sometimes interest capitalization is unavoidable (e.g., finishing school) or a consequence of a wise financial decision (e.g., switching IDR plans to lower your payment). However, you should avoid situations in which your unpaid interest is capitalized, if possible.