What Does "Capitalized Interest" Mean?

Student Loans

Most student loans involve capitalized interest. The loans a student receives for educational use are not placed in repayment status until six months after the student stops going to school, either as a result of graduation or withdrawal from courses. Interest that would have been due if the student was making payments on the loan while in school are capitalized and structured into the student's repayment plan.

Building Projects

When companies borrow money to build a long-term asset, such as a new building, the interest on the loan is capitalized during periods where the project is not available for use. In scenarios where a project requires multiple loans and various phases of building, capitalized interest may stop accruing on phases that are complete and ready for use. The loans on these phases may become payable as other phases of the project are still under construction.

Accounting for Capitalized Interest

Accountants must account for capitalized interest differently than normal interest expenses. Because capitalized interest is not immediately due and payable, as regular interest is in conventional loans, accountants must add the capitalized interest to the cost or value of the asset that funds were borrowed for to acquire. The total value of the asset is then listed as an asset of the business. Capitalized interest expenses are then accounted for over time through depreciation.

Avoiding Capitalization

Capitalized interest may be an unfavorable expense to many borrowers since it creates additional costs over time. Some lenders may give borrowers an opportunity to pay accrued interest before it is capitalized and added to the principal balance of the loan. If you take out a loan that allows capitalized interest accruals and you can afford to pay the accrued interest before your regular loan payments commence, you will save money over the life of the repayment by paying the interest before it is capitalized.