How to use the interest capitalization calculator
- Enter the loan balance and the interest rate.
- Enter the months of deferment, when no payments are made, and choose when unpaid interest is added to the balance.
- Enter the repayment term in months.
- Read the balance when repayment starts, the new payment and the extra cost of capitalizing compared with paying the interest as it builds.
Formula
interest builds each month at rate / 12 on the current balance
at each capitalization point, unpaid interest is added to the balance
new payment = balance x i / (1 - (1 + i)^-n), with i = rate / 12
extra cost = total interest with capitalizing - total interest if each month's interest were paid
The comparison column pays the simple interest on the starting balance each month during the deferment, then repays the original balance on the same term.
$20,000 at 6% deferred for a year
With interest added once at the end, 12 months builds $20,000 x 0.06 = $1,200, so repayment starts at $21,200.00. Over 120 months the payment rises from $222.04 on the original balance to $235.36.
The total interest during repayment goes from $6,644.92 to $7,043.62, which is $398.70 more, because the $1,200 now earns interest too. If interest is added every month instead, the balance at the end of the year is $21,233.56, since each month's interest earns interest in the months after it.
Why capitalization matters
Capitalization turns interest into principal. From then on, interest is charged on interest, which makes the loan cost more than it would if the interest had been paid. Paying even the interest during a deferment stops the effect. The size of the extra cost depends on the rate, the length of the deferment and the repayment term.
To plan extra payments after capitalization, use the Student Loan Payoff Calculator, and for the schedule use the Amortization Schedule Calculator. The related case of a payment too small to cover interest is in the Negative Amortization Schedule Calculator.
When interest is added
Loan terms differ: some add interest at the end of a grace period or deferment, some every month or year, and some only when a status changes. Pick the option that matches your terms. If your lender does not add the interest, the cost is just the interest itself.
Assumptions and limits
- Interest accrues as simple interest on the current balance each month and is added at the points you choose.
- No payments are made during the deferment and no fees are added.
- The repayment uses level monthly payments at the same rate.
- Subsidies, grace rules of particular programs and rate changes are not modeled.
- Check your loan documents for the actual terms; this is not financial advice.
Frequently asked questions
What does capitalized interest mean?
It is unpaid interest that has been added to the loan balance, so that later interest is charged on it as well.
How do I avoid the extra cost?
Pay the interest as it builds, even during a deferment, if you can. Then there is nothing to capitalize.
Why is the extra cost larger for a longer repayment?
The capitalized amount earns interest for the whole repayment term, so a longer term collects more interest on it.
Does the tool handle several deferments?
It handles one. Run it again with the new balance for the next one.