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Capitalize Interest

Save Now and Pay More Later

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Adding Machine Tape and Bank Interest Rate Figures
Andy Sotiriou/Photodisc/Getty Images
Question: What does it mean to capitalize interest on a loan?

Sometimes you can choose whether or not to pay interest on your loan. To be more precise, you (or somebody) always have to pay the interest -- it's just a matter of when.

Basics of Capitalizing

When you capitalize interest, you skip the interest payments. However, you still owe the money and you'll have to pay eventually. Your lender adds the interest charges to your loan balance, so you owe more and more as you capitalize. Capitalization is the process of adding interest charges to your existing loan balance.

As your loan balance increases, so do future interest charges. Capitalization is confusing because you don't receive additional funds. However, you enjoy the use of that money, keeping it in your pocket instead of making a payment. Your lender acts as if you borrowed those interest payments - and you pay additional interest on those interest charges.

Repayment Time

How will you actually pay for capitalized interest? When you repay your loan, you'll pay more because your loan continues to grow. Your monthly payments will be higher than they would have been if you didn't capitalize. In addition, you'll pay more in total interest over the life of your loan. Run some numbers to see how much it will truly cost to capitalize those interest costs:

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