Overview

Interest accrual on student loans happens daily based on your loan’s interest rate and principal. If you don’t pay that interest as it accrues, many loan programs will periodically add (capitalize) the unpaid interest to the principal. Once capitalized, the larger principal becomes the base for future interest — in effect you pay interest on interest.

How and when capitalization typically happens

  • End of a grace period or when you leave school: Unpaid interest that built up while you were in school or during a grace period can be capitalized when repayment officially begins. (Federal Student Aid guidance: https://studentaid.gov)
  • End of deferment or forbearance: Many federal and private loans capitalize interest when a deferment or forbearance ends if interest accrued during that time wasn’t paid. See consumer guidance from the CFPB: https://www.consumerfinance.gov
  • Loan consolidation or certain repayment plan changes: Consolidating loans or switching plans can trigger capitalization of accrued interest that hasn’t been paid.
  • Administrative triggers: Some servicer actions (for example, switching servicers or exiting an income-driven repayment trial) can cause capitalization depending on loan type and timing.

Note: Subsidized federal loans don’t accrue interest while you’re in school or in approved deferment, but unsubsidized loans do. Always check your loan terms at Federal Student Aid (studentaid.gov).

A clear example

  • Original principal: $20,000
  • Interest rate: 5% (simple annual rate)
  • Time in school/deferment: 4 years

Approximate accrued interest = $20,000 × 0.05 × 4 = $4,000. If that unpaid interest is capitalized at repayment, your new principal becomes $24,000. Future interest is calculated on $24,000, so you’ll pay more each month and more total interest over the life of the loan than if you had paid the $4,000 of interest as it accrued.

(Technical note: federal and private student loans typically accrue interest daily; the simple formula above illustrates magnitude but daily accrual and rounding rules slightly change the exact amount.)

Who is most affected

  • Borrowers with unsubsidized federal loans or private loans that accrue interest during school or deferment.
  • Borrowers who enter long deferment or forbearance periods.
  • Those who consolidate loans without paying accrued interest first.

Practical strategies to limit capitalization (what I recommend in practice)

  1. Pay interest while in school or during deferment/forbearance if you can. Even small monthly payments that cover accrued interest prevent capitalization and compound savings over time.
  2. Make interest-only payments if full payments aren’t possible. Ask your servicer how to designate payments as interest payments so they don’t go toward principal.
  3. Understand loan types. Know which loans are subsidized and unsubsidized — see our guide to loan differences for details: “Loan Subsidized vs Unsubsidized: How Different Student Loans Accrue Interest” (https://finhelp.io/glossary/loan-subsidized-vs-unsubsidized-how-different-student-loans-accrue-interest/).
  4. Avoid unnecessary consolidation before you’re ready. Consolidation can capitalize unpaid interest and may reset benefits tied to original loans. If considering refinancing, weigh loss of federal protections: see “Refinancing Graduate Student Loans: Timing and Eligibility” (https://finhelp.io/glossary/refinancing-graduate-student-loans-timing-and-eligibility/).
  5. Use short-term strategies to reduce accrual. For example, targeted payments or paying interest during short enrollment changes can limit growth — see our strategies for reducing interest accrual before repayment: “Strategies for Reducing Interest Accrual on Student Loans Before Repayment” (https://finhelp.io/glossary/strategies-for-reducing-interest-accrual-on-student-loans-before-repayment/).

Common misconceptions

  • “Capitalization only affects monthly payments”: It affects both monthly payments and total interest paid over the life of the loan because future interest is calculated on a larger principal.
  • “All loans stop accruing interest in deferment”: Subsidized federal loans don’t accrue during certain deferments, but many loan types (including unsubsidized federal and most private loans) do.

Quick FAQ

  • Can I avoid capitalization completely? Often yes — by paying accrued interest before a capitalization event or by choosing repayment options that capitalize less frequently. Check with your servicer for exact triggers.
  • Will capitalization change my interest rate? No. Capitalization increases the principal; the stated interest rate typically remains the same, but interest charges increase because they’re applied to a larger balance.

Authoritative sources

Professional disclaimer

This article is educational and not personalized financial advice. In my experience advising borrowers, small interest payments during school or deferment are often the most cost-effective way to limit capitalization. For tailored guidance, consult a qualified financial counselor or your loan servicer.