What Does Capitalized Mean for a Loan?
When you borrow money from a company in the business of lending money, you will have to pay back the loan. More than likely, you will also need to pay interest on that loan. If, however, you neglect to pay that interest, the interest can capitalize. The capitalization of the interest on the loan increases the amount of money you have to pay back to your lender.
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Money Owed
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When you borrow money from a commercial lender, you have three categories of money that you will owe when you begin repaying the money: the loan, the interest and the principal. The loan is the amount of money you borrowed from the lender. Interest is the expense charged for borrowing the money. The lender calculates interest as a percentage of the amount of the loan. The principal is the amount of money you owe on the loan, and the principal includes any capitalized interest.
Interest Rates
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If you have borrowed money from a commercial lender, you probably did so at an interest rate. Check your loan contract to find out the interest rate you will pay on the money your borrowed. A low interest rate would be 3 percent, while 24 percent would be a high interest rate. You would do well to pay any loan with a high interest rate as soon as possible, because once the interest on a loan capitalizes, the balance on your loan will increase. Capitalization would increase the amount of money you will need to fully repay on the loan.
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Time of Capitalization
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You can also check your loan contract to determine at which junctures capitalization can occur. While a loan is in repayment it can capitalize in the following circumstances: when the loan goes into repayment; when the loan comes out of deferment; when the loan comes out of forbearance and at a set time, which would be disclosed in the loan contract.
Example of Capitalized Interest
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One type of loan that can quickly accrue interest and capitalize is a student loan. Take this example of interest capitalizing on a student loan: You have a student loan of $50,000 with a 6 percent interest rate. You have a minimum monthly payment of $441.67 for 10 years. You finish your education but do not find a job until a year after your graduation. Your repayment period kicks in six months after graduation, so you defer your loan payments for six months. Although, you do not have to pay at this time, interest continues to accrue on the loan. By deferring payment for six months, $1,500 accrues. The interest capitalizes, causing the amount of your principal balance to grow to $51,500.
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