Interest Capitalization

Full definition

Capitalization is the mechanism by which interest-on-interest (compound interest) can silently inflate a loan balance. It is especially important to understand in personal loans with deferred payment periods or during forbearance. How it works: Suppose you defer two months of payments on a $10,000 personal loan at 18% APR. During those two months, approximately $298 of interest accrues. If the lender capitalizes this interest, the new principal balance becomes $10,298. Going forward, all future interest calculations are based on $10,298, not $10,000. This increases every future payment slightly and adds to the total interest you will pay over the remaining term. When capitalization occurs: Capitalization can happen at the end of a grace or deferral period, after a forbearance ends, when missed payments are formally added to the balance, or at other contractual trigger points defined in the loan agreement. Personal loan vs. student loan context: Capitalization is most aggressively discussed in student loan contexts, where interest can accrue for years during in-school deferment. For personal loans, which typically have shorter terms and no in-school periods, capitalization events are less frequent and the dollar impact is smaller but still real. How to minimize it: Pay interest-only if allowed during any deferral period. Make payments before the capitalization trigger date when possible. If choosing between forbearance and deferral options, ask the lender whether and when unpaid interest will be capitalized. Check your loan agreement: The promissory note or loan agreement should specify whether and when the lender capitalizes unpaid interest. If it is unclear, ask before accepting any deferral or modification offer.

• Accrued Interest
• Deferred Payment
• Amortization
• Forbearance