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How to Avoid Capitalized Interest on Student Loans
Capitalized interest on student loans may not be the next hot topic to debate at your dinner party, but it is a financial concept worth discussing at some point. If you’re one of the 43 million Americans considering or already carrying student loans, you’ll want to understand how student loan interest capitalization affects your payments. Capitalization is a bigger issue than most realize. In 2019 alone, the government capitalized $21.7 billion in unpaid interest on outstanding student loans.
Undergraduate & Graduate
*College Ave Student Loans products are made available through either Firstrust Bank, member FDIC or M.Y. Safra Bank, FSB, member FDIC. All loans are subject to individual approval and adherence to underwriting guidelines. Program restrictions, other terms, and conditions apply. Rates shown are for the College Ave Undergraduate Loan product and include autopay discount. The 0.25% auto-pay interest rate reduction applies as long as a valid bank account is designated for required monthly payments. Variable rates may increase after consummation. This informational repayment example uses typical loan terms for a freshman borrower who selects the Deferred Repayment Option with a 10-year repayment term, has a $10,000 loan that is disbursed in one disbursement and a 8.35% fixed Annual Percentage Rate (“APR”): 120 monthly payments of $179.18 while in the repayment period, for a total amount of payments of $21,501.54. Loans will never have a full principal and interest monthly payment of less than $50. Your actual rates and repayment terms may vary. As certified by your school and less any other financial aid you might receive. Minimum $1,000. Information advertised valid as of 7/22/2021. Variable interest rates may increase after consummation. Approved interest rate will depend on the creditworthiness of the applicant(s), lowest advertised rates only available to the most creditworthy applicants and require selection of full principal and interest payments with the shortest available loan term.
Due to the nature of Credible’s student loan purchase and refinancing platform, we are unable to assign it a SimpleScore, as the rates, fees and loan amounts depend on the lender you choose from its marketplace.
Rates displayed include Automatic Payment and Loyalty Discounts, where applicable. Note that such discounts do not apply while loans are in deferment. The lenders on the Credible.com platform offer fixed rates ranging from 3.34% – 14.50% APR and Variable interest rates from 1.04% – 13.19% APR. Variable rates will fluctuate over the term of the borrower’s loan with changes in the LIBOR rate. Rates are subject to change at any time without notice. Your actual rate may be different from the rates advertised and/or shown above and will be based on factors such as the term of your loan, your financial history (including your cosigner’s (if any) financial history) and the degree you are in the process of achieving or have achieved. While not always the case, lower rates typically require creditworthy applicants with creditworthy co-signers, graduate degrees, and shorter repayment terms (terms vary by lender and can range from 5-20 years) and include Automatic Payment and Loyalty discounts, where applicable. Loyalty and Automatic Payment discount requirements as well as Lender terms and conditions will vary by lender and therefore, reading each lender’s disclosures is important. Additionally, lenders may have loan minimum and maximum requirements, degree requirements, educational institution requirements, citizenship and residency requirements as well as other lender-specific requirements.
Eligibility for federal, state and university funded financial aid is determined by completing the Free Application for Federal Student Aid (FAFSA). All students are strongly encouraged to apply for federal aid by completing the FAFSA, which can be obtained online at www.fafsa.ed.gov.
Students can check their eligibility for a private student loan with LendKey and our network of private student loan lenders by starting a student loan application.
Repayment Options: Deferred, $25 Fixed ² , or Interest Repayment during school ¹
1 Lowest rates shown include auto debit discount. Advertised rates are for the Smart Option Student Loan for undergraduate students and are valid as of 7/1/2021. Interest is charged starting when funds are sent to the school. With the Fixed and Deferred Repayment Options, the interest rate is higher than with the Interest Repayment Option and Unpaid Interest is added to the loan’s Current Principal at the end of the grace/separation period. Payments may be required during the grace/ separation period depending on the repayment option selected. Variable rates may increase over the life of the loan. Advertised variable rates reflect the starting range of rates and may vary outside of that range over the life of the loan. Advertised APRs assume a $10,000 loan to a freshman with no other Sallie Mae loans. The borrower or cosigner must enroll in auto debit through Sallie Mae to receive a 0.25 percentage point interest rate reduction benefit. This benefit applies only during active repayment for as long as the Current Amount Due or Designated Amount is successfully withdrawn from the authorized bank account each month. It may be suspended during forbearance or deferment, if available for the loan.
2 Examples of typical transactions for a $10,000 Smart Option Student Loan With the most common variable rate, fixed repayment option, 6-month separation period, and two disbursements: For a borrower with no prior loans and a 4-year In-school period, it works out to a 6.88% APR, 51 payments of $25 00, 119 payments of $136.17 and one payment of $112.58, for a Total Loan Cost of $17,591.81. For a borrower with $20,000 In prior loans and a 2-year In-school period, it works out to a 7.06% APR, 27 payments of $25.00, 179 payments of $98.17 and one payment of $66.85 for a total loan cost of $18,314.28. Loans that are subject to a $50 minimum principal and interest payment amount may receive a loan term that is less than 10 year. Variable rates may increase over the life of the loan.
Disclosure: UNDERGRADUATE LOANS: Fixed rates from 3.49% to 10.66% annual percentage rate (“APR”) (with autopay), variable rates from 1.12% to 11.23% APR (with autopay). GRADUATE LOANS: Fixed rates from 4.13% to 10.90% APR (with autopay), variable rates from 1.10% to 11.34% APR (with autopay). MBA AND LAW SCHOOL LOANS: Fixed rates from 4.08% to 10.86% APR (with autopay), variable rates from 1.05% to 11.29% APR (with autopay). PARENT LOANS: Fixed rates from 4.23% to 10.66% APR (with autopay), variable rates from 1.20% to 11.23% APR (with autopay). For variable rate loans, the variable interest rate is derived from the one-month LIBOR rate plus a margin and your APR may increase after origination if the LIBOR increases. Changes in the one-month LIBOR rate may cause your monthly payment to increase or decrease. Interest rates for variable rate loans are capped at 13.95%, unless required to be lower to comply with applicable law. Lowest rates are reserved for the most creditworthy borrowers. If approved for a loan, the interest rate offered will depend on your creditworthiness, the repayment option you select, the term and amount of the loan and other factors, and will be within the ranges of rates listed above. The SoFi 0.25% autopay interest rate reduction requires you to agree to make monthly principal and interest payments by an automatic monthly deduction from a savings or checking account. The benefit will discontinue and be lost for periods in which you do not pay by automatic deduction from a savings or checking account. Information current as of 11/04/2020. Enrolling in autopay is not required to receive a loan from SoFi. SoFi Lending Corp., licensed by the Department of Business Oversight under the California Financing Law License No. 6054612. NMLS #1121636 (www.nmlsconsumeraccess.org).
*College Ave Student Loans products are made available through either Firstrust Bank, member FDIC or M.Y. Safra Bank, FSB, member FDIC. All loans are subject to individual approval and adherence to underwriting guidelines. Program restrictions, other terms, and conditions apply. All rates shown include the autopay discount. The 0.25% auto-pay interest rate reduction applies as long as the borrower or cosigner, if applicable, enrolls in auto-pay and authorizes our loan servicer to automatically deduct your monthly payments from a valid bank account via Automated Clearing House (“ACH”). The rate reduction applies for as long as the monthly payment amount is successfully deducted from the designated bank account and is suspended during periods of forbearance and certain deferments. Variable rates may increase after consummation. This informational repayment example uses typical loan terms for a refi borrower with a Full Principal & Interest Repayment and a 10-year repayment term, has a $40,000 loan and a 5.5% Annual Percentage Rate (“APR”): 120 monthly payments of $434.11 while in the repayment period, for a total amount of payments of $52,092.61. Loans will never have a full principal and interest monthly payment of less than $50. Your actual rates and repayment terms may vary. $5,000 is the minimum requirement to refinance. The maximum loan amount is $300,000 for those with medical, dental, pharmacy or veterinary doctorate degrees, and $150,000 for all other undergraduate or graduate degrees. Information advertised valid as of 6/10/2021. Variable interest rates may increase after consummation.
The lenders on the Credible.com platform offer fixed rates ranging from 2.16% – 9.15% (2.16% – 9.15% APR). Variable interest rates offered by the lenders on Credible.com range from 1.87% – 8.90% (1.87% – 8.90% APR). Variable rates will fluctuate over the term of the borrower’s loan with changes in the LIBOR rate. The maximum variable rate on the Education Refinance Loan is the greater of 21.00% or Prime Rate plus 9.00%. Rates are subject to change at any time without notice. Your actual rate may be different from the rates advertised and/or shown above and will be based on factors such as the term of your loan, your financial history (including your cosigner’s (if any) financial history) and the degree you are in the process of achieving or have achieved. While not always the case, lower rates typically require creditworthy applicants with creditworthy co-signers, graduate degrees, and shorter repayment terms (terms vary by lender and can range from 5-20 years) and include loyalty and Automatic Payment discounts, where applicable. Loyalty and Automatic Payment discount requirements as well as Lender terms and conditions will vary by lender and therefore, reading each lender’s disclosures is important. Additionally, lenders may have loan minimum and maximum requirements, degree requirements, educational institution requirements, citizenship and residency requirements as well as other lender-specific requirements.
Education Loan Finance is a nationwide student loan debt consolidation and refinance program offered by Tennessee based SouthEast Bank. ELFI is designed to assist borrowers through consolidating and refinancing loans into one single loan that effectively lowers your cost of education debt and/or makes repayment very simple. Subject to credit approval. See Terms & Conditions. Interest rates current as of 07-29-2020. The interest rate and monthly payment for a variable rate loan may increase after closing, but will never exceed 9.95% APR. Interest rates may be different from the rates shown above and will be based on the term of your loan, your financial history, and other factors, including your cosigner’s (if any) financial history. See Eligibility Requirements for more information. For example, a 10-year loan with a fixed rate of 6% would have 120 payments of $11.00 per $1,000 borrowed. Rates are subject to change.
The minimum loan amount is $5,000 (Except if you are a resident of AZ: $10,001; CT: $15,001; MA: $6,000). The maximum is $125,000 if you have an undergraduate degree, $175,000 if you have a graduate degree, and $300,000 for select medical degrees.
Fixed rates from 2.74% APR to 6.74% APR (with autopay). Variable rates from 2.25% APR to 6.39% APR (with autopay). All variable rates are based on the 1-month LIBOR and may increase after consummation if LIBOR increases; see more at SoFi.com/legal/#1. If approved for a loan your rate will depend on a variety of factors such as your credit profile, your application and your selected loan terms. Your rate will be within the ranges of rates listed above. Lowest rates reserved for the most creditworthy borrowers. SoFi refinance loans are private loans and do not have the same repayment options that the federal loan program offers, or may become available, such as Income Based Repayment or Income Contingent Repayment or PAYE. SoFi loans are originated by SoFi Lending Corp. or an affiliate (dba SoFi), a lender licensed by the Department of Financial Protection and Innovation under the California Financing Law, license #6054612; NMLS #1121636 (www.nmlsconsumeraccess.org). Additional terms and conditions apply; see SoFi.com/eligibility for details. SOFI RESERVES THE RIGHT TO MODIFY OR DISCONTINUE PRODUCTS AND BENEFITS AT ANY TIME WITHOUT NOTICE.
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First, it’s important to understand the basic definition of capitalized interest. It’s interest that has been tacked on to the end of your loan balance due to unpaid payments, which means you’re basically paying interest on top of interest.
Capitalized interest can affect both federal and private student loans. Capitalization occurs when you aren’t paying your student loan payments and therefore aren’t paying the interest on the loans. Common examples of this are deferment (on unsubsidized loans) and forbearance.
How much does this interest cost?
Interest capitalization will impact how much you pay on your student loans. But how much extra are we talking about?
Let’s assume you borrow $50,000 in federal student loans, at the current interest rate of 6.6%. Then you use a six-month deferment period and the interest begins to capitalize. This results in $1,663 in capitalized interest — in addition to the $18,434 you’re paying in interest over the life of the loan. This affects your monthly payment. For a 10-year repayment plan, your monthly payment is $570.29 per month, but with the added interest from capitalization, it increases to $589.26 monthly.
The bottom line: paying capitalized interest on your student loans means you will pay more for your loan.
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Why do interest rates capitalize on student loans?
There are several scenarios where federal loans are subject to capitalization. Private loans are also subject to capitalization, but you’ll need to confirm with the private lender.
Deferment. To defer your student loans means you are under a grace period where you pay neither principal nor interest. However, with unsubsidized federal loans, the interest continues to accrue and you have to pay back the interest once the deferment period has ended.
Forbearance. Forbearance is when you pause your payments on your federal student loans, no matter what type of loan you have. The interest continues to accrue and you have to pay it back once the forbearance period is complete.
Opting out of certain repayment plans. If your federal loans are under the Revised Pay as You Earn (REPAYE), Pay as You Earn (PAYE) or Income-Based Repayment (IBR) plans and you opt-out of these programs, you will have to pay capitalized interest.
Income requirements resulting in lower minimum payments. If you are enrolled in certain income-driven repayment plans, your lower income may mean a reduction in monthly payments. If the amount of your monthly payment isn’t enough to cover the total interest on your loans, then the interest will capitalize.
Ways to avoid capitalized interest on student loans
Although the thought of paying interest for several years can be overwhelming, there is a way to reduce or avoid capitalized interest on student loans.
Continue making interest payments. If you decide to take advantage of a deferment or forbearance period, you can choose to pay just the interest during the designated time period.
Pay off your loans or at least make extra payments. You can pay off your student loans before the end of the term, and this will help you avoid the capitalized interest on your student loans. Or, if you ever have a little extra you can pay towards your loans, then you can save from this too. It’s easier said than done, but you’ll be saving potentially thousands on both capitalized interest and interest over the life of the loan.
Refinance. Another way to avoid capitalization altogether is to refinance your student loans. With the competitive rates in the market today, this could be a chance to avoid the capitalization and lower your monthly payments. A word of caution though — by refinancing federal student loans, you automatically remove yourself from eligibility for student loan forgiveness programs, such as the Public Service Loan Forgiveness Program (or PSLF) and income-driven repayment plans. Refinancing can also get trickier if you have less-than-stellar credit, but it’s still worth comparing.
Don’t switch repayment plans too often. When you switch from one plan to another, the interest you accrued on one plan will be capitalized on your new repayment plan.
What you should know about consolidating your student loan
Another hot topic among student loans is the idea of consolidating. Not to be confused with refinancing, loan consolidation is when you combine your student loans into one monthly payment. For federal loans, this is referred to as a Direct Consolidation Loan and is administered through the Office of Federal Aid. The interest rate is determined by taking the weighted average of the interest rates from the loans you’re consolidating. This same concept can also apply to private student loans, but you would work with a private lender. You can also choose to consolidate federal loans into a private consolidated loan.
When you consolidate your federal student loans, any accrued interest from your income-driven repayment plans will be capitalized on your new, Direct Consolidation Loan. This will affect both your monthly payment and how much you pay over the life of your loan.
Sara Coleman is a personal finance journalist based in Charlotte, NC. A journalism major who studied at the University of Georgia, she enjoys creating approachable content. She’s written for sites such as The Simple Dollar, Interest.com, WorkingMother, BetterYouMag and SmartMoneyMamas. She loves spending time with her husband and three kids, and has a healthy obsession with coffee.