Interest capitalization, and what it actually costs

This site leads with capitalization because the misunderstanding around it runs in both directions. People who have heard of it tend to overestimate what it costs. People who have not sometimes pay for it without ever seeing it named.

The mechanic

While you are not making payments, interest accrues on your loan. You owe it. On a federal loan it sits outside your principal, in a separate bucket, and money in that bucket does not earn anything.

Capitalization is the moment that bucket is emptied into your principal. Nothing about the amount changes. What changes is that from then on, the loan charges interest on it.

So the cost of capitalization is not the interest that accrued. That was always going to be owed. The cost is the interest charged on that interest for the rest of the loan, and it is smaller than people expect.

A worked example

Someone borrows $27,000 across four years of study on an unsubsidized loan at 6.52%, the undergraduate rate for 2026-27. They pay nothing while studying, and nothing during the six-month grace period. Interest accrues throughout.

Interest accrued before the first payment is due: $7,921.80. This is owed whether or not it capitalizes.
If it capitalizes, repayment starts from $34,921.80 rather than $27,000.
Over a ten-year term, capitalizing costs an extra $2,881.93.

That last figure is the answer to the question. It is not $7,921.80, which is the figure usually quoted.

Run the same arithmetic on your own numbers.

When it happens on a US federal loan

Much less often than it used to. Regulations effective 2023-07-01 removed most of the triggers. On a Direct Loan, or a loan from the old FFEL programme that the Department now holds, this is the complete list:

The end of a deferment on an unsubsidized loan. Interest accrues throughout a deferment on an unsubsidized loan, and joins the principal when the deferment ends. On a subsidized loan the government pays that interest, so there is nothing to capitalize.
Leaving Income-Based Repayment, or no longer qualifying for an income-based payment. Both halves matter. Choosing to leave IBR capitalizes, and so does an income rising to the point where the income-based calculation no longer produces a payment below the cap.

Two events. Both survived because they are written into the statute rather than into a regulation, which is why the Department could not remove them along with the others.

What was removed, and why your balance may still show it

These no longer capitalize on a Department-held loan:

Leaving a forbearance. The most common trigger there was, and the most valuable removal.
The end of the grace period on an unsubsidized loan. Interest from school and grace is still owed. It simply no longer earns interest of its own.
Entering repayment
Default
Entering or leaving PAYE, or leaving REPAYE. IBR is the exception that survived, because its trigger is statutory rather than regulatory.

The change was not retroactive. If your interest capitalized before July 2023 it is part of your principal permanently, and it explains why your balance can be larger than the sum of everything you were ever handed.

The exception that catches people out

All of the above applies to loans the Department holds. A FFEL loan still held commercially is on the old rules, and four events capitalize rather than two:

The end of a deferment on an unsubsidized loan
Leaving Income-Based Repayment, or no longer qualifying for an income-based payment
The end of a forbearance, on any type of loan
The end of the grace period on an unsubsidized loan

If you are not sure which kind you have, your servicer can tell you, and it changes the answer materially.

Consolidation, which is not on the list and behaves like it is

Consolidating does not appear on the Department's list of capitalization events, and it has the same effect. Accrued interest on the loans being consolidated becomes part of the principal of the new loan, and earns interest from then on.

The Repayment Assistance Plan mostly removes the problem

Under RAP, interest that a full and on-time payment does not cover is waived rather than carried. There is nothing left to capitalize later. That applies to subsidized and unsubsidized loans alike, for as long as you stay in the plan, and it is why the Department can say a balance in RAP never grows.

It only covers interest accruing after you enter the plan, and only in months where the payment was made in full and on time. Interest that accrued before you joined is untouched.

In Canada

The federal portion of a Canada Student Loan has carried no interest since April 2023, so there is nothing to accrue and nothing to capitalize. That is the whole story for the federal half, everywhere in the country.

The provincial half is a different matter, and Ontario is where capitalization is still live. Interest accrues on the Ontario portion at prime plus one percent during the six-month grace period, and Ontario adds it to the principal at the end of it. Quebec does the same: interest accrues during its grace period, and leaving it unpaid capitalizes it.

British Columbia and New Brunswick eliminated interest on their portions, so an integrated loan in either is genuinely interest-free on both halves. Alberta charges interest but its twelve-month grace period is interest-free.

The blanket claim that Canadian student loans are interest-free is true federally and false in the three provinces holding most of the country's borrowers. Check your own province.

Private loans have no rules at all

No federal rule limits when a private student loan capitalizes. The terms are whatever the contract says, and lenders commonly capitalize at the end of the in-school period, at the end of grace, at the end of every deferment or forbearance, and on conversion to repayment. Some capitalize monthly or quarterly during deferment. The one federal requirement is disclosure: Regulation Z requires the lender to tell you the capitalization terms at application, at approval and at closing.

How the interest is calculated

Outstanding principal, multiplied by the interest rate divided by 365.25, multiplied by the number of days since the last payment.

The Department's own worked example: $10,000 at 6.8% accrues $1.86 a day. Six months of deferment adds $340, and capitalizing that makes the principal $10,340, at which point the daily accrual rises to $1.93. That last step is capitalization in one sentence.

What to actually do about it

Paying the interest during school or a deferment, even partly, stops there being anything to capitalize. It does not have to be much.
On a Direct Loan, forbearance no longer capitalizes. If you were avoiding it for that reason, the reason no longer holds.
Leaving Income-Based Repayment does capitalize. If you are moving off it, that is worth knowing before rather than after.
A subsidized loan accrues nothing during school, grace or an authorised deferment. Where you have a choice about which to take first, that is what the subsidy is worth.