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Capitalization (Interest)
Definition
Addition of unpaid accrued interest to the principal balance, increasing the total loan amount.
Explanation
Capitalization occurs when unpaid interest is added to your loan principal after deferment, forbearance, grace periods, or leaving an IDR plan. This increases your principal, and future interest is calculated on this larger amount — creating compounding debt growth.
Capitalization can significantly increase total loan cost. Paying interest as it accrues rather than letting it capitalize saves money over the life of the loan.
Example
$50,000 loan accrues $2,000 unpaid interest during deferment. It capitalizes: new principal = $52,000. Future interest calculated on $52,000 instead of $50,000.