Advisor information presented at November 2, 2021 Negotiated Rulemaking 

1. Interest capitalization example 

Note: This document was prepared by Dr. Rajeev Darolia, Advisor for economic and higher education policy analysis and 

data, for the 2021 Affordability and Student Loans Committee Meetings as part of the 2021-22 US Department of Education 

Negotiated Rulemaking for Higher Education. Please forgive any errors in analyses produced in an expeditious manner. 1 
 

 

 

 

 

 

 

Terms defined 

● Interest capitalization: when unpaid interest is added to the principal amount of a loan 

● Some common reasons for unpaid interest 

• Periods of non-payment (e.g., deferment or forbearance, depending on type of loan) 

• Payment being less than amount of interest accrued on an IDR plan 

● Some examples of things that can lead to interest capitalization (currently) 

• Following periods of deferment on an unsubsidized loan and/or forbearance on any types of loans 

• Following the grace period on an unsubsidized loan 

• Voluntarily exit from the Revised Pay as You Earn, Pay as You Earn (PAYE) or Income-Based Repayment (IBR) plans 

• Fail to annually update income for some of the income-driven plans 

• If repaying loans under the PAYE or IBR plans and no longer qualify to make payments based on income 

● In some plans, unpaid interest is currently subsidized by ED for some time and, for some 

plans and types of loans, for the entire period of repayment 

Sources: https://studentaid.gov/understand-aid/types/loans/interest-rates and https://studentaid.gov/manage-loans/repayment/plans/income-driven/questions 

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Treatment of lnt,erest wi·th 

DefermentJIForbearance 

~ terest ·s p .. d 

I~ · te rest · s c: ital izedl .at' ·rh e 

end 

~ terest ·s ca . italized 

quarterly and] at the· end 

!Loan Ca p1ita I ized 

Amo1u · t lnt,erest 

$,3,0,.000 0 

$1,800 

$1,841 

Outst nding Monthly ·. umber iof Total 

Principal Paym,ent P,ayments Rep1ai·d 

30,000 $,3,33 120 41,.767 

120 

· 31,841 $3,54 120 · 42,420 

Example capitalization chart 

Source: Table 1, Economic Hardship Deferment Request, US Department of Education 

Assumptions: $30,000 unsubsidized loan, 6% interest rate, deferment or forbearance for 12 months at beginning of 

repayment 

Quarterly capitalization and at the end leads to a higher monthly payment and total amount repaid than does just 

capitalization at the end. 

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Fictional borrower example (Charlotte), without interest capitalization 

Period 

(Month) Income Income 

Protection 

Discretionary 

Income 

Income 

Assessment Payment 

Principal 

(beginning 

of period) 

Interest 

Rate 

Interest 

Due Principal Paid Unpaid 

Interest 

Principal 

(end of period) 

[A] [B] [C] 

= [A] – [B] 

[D] [E] 

= [C] X [D] 

[F] 

= [K]t-1 

[G] [H] 

= [F] X [G] 

[I] 

= MAX([E]-[H],0) 

[J] 

= MAX([H]-[E],0) 

[K] 

= [F] – [I] 

0 28000 

1 2000 1610 390 0.1 39 28000 0.003108 87 0 48 28000 

2 2000 1610 390 0.1 39 28000 0.003108 87 0 48 28000 

3 2000 1610 390 0.1 39 28000 0.003108 87 0 48 28000 

4 2000 1610 390 0.1 39 28000 0.003108 87 0 48 28000 

5 2000 1610 390 0.1 39 28000 0.003108 87 0 48 28000 

6 2000 1610 390 0.1 39 28000 0.003108 87 0 48 28000 

7 2000 1610 390 0.1 39 28000 0.003108 87 0 48 28000 

8 2000 1610 390 0.1 39 28000 0.003108 87 0 48 28000 

9 2000 1610 390 0.1 39 28000 0.003108 87 0 48 28000 

10 2000 1610 390 0.1 39 28000 0.003108 87 0 48 28000 

11 2000 1610 390 0.1 39 28000 0.003108 87 0 48 28000 

12 2000 1610 390 0.1 39 28000 0.003108 87 0 48 28000 

Assumptions: Household size = 1; Interest rate = 3.73%; Income protection = 150% Poverty Line. CAVEATS: Estimates are approximations for illustrative purposes about individual repayment 

scenarios; Scenarios are in the spirit of IBR plans but does not explicitly model all aspects of current IBR policies. 4 
 

 

 

 

Fictional borrower example (Charlotte), with monthly interest capitalization 

Period 

(Month) Income Income 

Protection 

Discretionary 

Income 

Income 

Assessment Payment 

Principal 

(beginning 

of period) 

Interest 

Rate 

Interest 

Due Principal Paid Unpaid 

Interest 

Principal 

(end of period) 

[A] [B] [C] 

= [A] – [B] 

[D] [E] 

= [C] X [D] 

[F] 

= [K]t-1 

[G] [H] 

= [F] X [G] 

[I] 

= MAX([E]-[H],0) 

[J] 

= MAX([H]-[E],0) 

[K] 

= [F] – [I] + [J] 

0 28000 

1 2000 1610 390 0.1 39 28000 0.003108 87.0 0 48.0 28048 

2 2000 1610 390 0.1 39 28048 0.003108 87.2 0 48.2 28096 

3 2000 1610 390 0.1 39 28096 0.003108 87.3 0 48.3 28145 

4 2000 1610 390 0.1 39 28145 0.003108 87.5 0 48.5 28193 

5 2000 1610 390 0.1 39 28193 0.003108 87.6 0 48.6 28242 

6 2000 1610 390 0.1 39 28242 0.003108 87.8 0 48.8 28290 

7 2000 1610 390 0.1 39 28290 0.003108 87.9 0 48.9 28339 

8 2000 1610 390 0.1 39 28339 0.003108 88.1 0 49.1 28388 

9 2000 1610 390 0.1 39 28388 0.003108 88.2 0 49.2 28438 

10 2000 1610 390 0.1 39 28438 0.003108 88.4 0 49.4 28487 

11 2000 1610 390 0.1 39 28487 0.003108 88.5 0 49.5 28537 

12 2000 1610 390 0.1 39 28537 0.003108 88.7 0 49.7 28586 

Assumptions: Household size = 1; Interest rate = 3.73%; Income protection = 150% Poverty Line. Estimates are approximations for illustrative purposes about individual repayment scenarios; 

Scenarios are in the spirit of IBR plans but does not explicitly model all aspects of current IBR policies. 5 
 

 

 

Fictional borrower example (Charlotte), with interest capitalization at periods 6 and 12 

Period 

(Month) Income Income 

Protection 

Discretionary 

Income 

Income 

Assessment Payment 

Principal 

(beginning 

of period) 

Interest 

Rate 

Interest 

Due Principal Paid Unpaid 

Interest 

Principal 

(end of period) 

[A] [B] [C] 

= [A] – [B] 

[D] [E] 

= [C] X [D] 

[F] 

= [K]t-1 

[G] [H] 

= [F] X [G] 

[I] 

= MAX([E]-[H],0) 

[J] 

= MAX([H]-[E],0) 

[K] 

0 28000 

1 2000 1610 390 0.1 39 28000 0.003108 87.0 0 48.0 28000 

2 2000 1610 390 0.1 39 28000 0.003108 87.0 0 48.0 28000 

3 2000 1610 390 0.1 39 28000 0.003108 87.0 0 48.0 28000 

4 2000 1610 390 0.1 39 28000 0.003108 87.0 0 48.0 28000 

5 2000 1610 390 0.1 39 28000 0.003108 87.0 0 48.0 28000 

6 2000 1610 390 0.1 39 28000 0.003108 87.0 0 48.0 28288 

7 2000 1610 390 0.1 39 28288 0.003108 87.9 0 48.9 28288 

8 2000 1610 390 0.1 39 28288 0.003108 87.9 0 48.9 28288 

9 2000 1610 390 0.1 39 28288 0.003108 87.9 0 48.9 28288 

10 2000 1610 390 0.1 39 28288 0.003108 87.9 0 48.9 28288 

11 2000 1610 390 0.1 39 28288 0.003108 87.9 0 48.9 28288 

12 2000 1610 390 0.1 39 28288 0.003108 87.9 0 48.9 28582 

Assumptions: Household size = 1; Interest rate = 3.73%; Income protection = 150% Poverty Line. Estimates are approximations for illustrative purposes about individual repayment scenarios; 

Scenarios are in the spirit of IBR plans but does not explicitly model all aspects of current IBR policies. 6 
 

 

 

Fictional borrower example (Charlotte), with interest capitalization at period 12 

Period 

(Month) Income Income 

Protection 

Discretionary 

Income 

Income 

Assessment Payment 

Principal 

(beginning 

of period) 

Interest 

Rate 

Interest 

Due Principal Paid Unpaid 

Interest 

Principal 

(end of period) 

[A] [B] [C] 

= [A] – [B] 

[D] [E] 

= [C] X [D] 

[F] 

= [K]t-1 

[G] [H] 

= [F] X [G] 

[I] 

= MAX([E]-[H],0) 

[J] 

= MAX([H]-[E],0) 

[K] 

0 28000 

1 2000 1610 390 0.1 39 28000 0.003108 87.0 0 48.0 28000 

2 2000 1610 390 0.1 39 28000 0.003108 87.0 0 48.0 28000 

3 2000 1610 390 0.1 39 28000 0.003108 87.0 0 48.0 28000 

4 2000 1610 390 0.1 39 28000 0.003108 87.0 0 48.0 28000 

5 2000 1610 390 0.1 39 28000 0.003108 87.0 0 48.0 28000 

6 2000 1610 390 0.1 39 28000 0.003108 87.0 0 48.0 28000 

7 2000 1610 390 0.1 39 28000 0.003108 87.0 0 48.0 28000 

8 2000 1610 390 0.1 39 28000 0.003108 87.0 0 48.0 28000 

9 2000 1610 390 0.1 39 28000 0.003108 87.0 0 48.0 28000 

10 2000 1610 390 0.1 39 28000 0.003108 87.0 0 48.0 28000 

11 2000 1610 390 0.1 39 28000 0.003108 87.0 0 48.0 28000 

12 2000 1610 390 0.1 39 28000 0.003108 87.0 0 48.0 28576 

Assumptions: Household size = 1; Interest rate = 3.73%; Income protection = 150% Poverty Line. Estimates are approximations for illustrative purposes about individual repayment scenarios; 

Scenarios are in the spirit of IBR plans but does not explicitly model all aspects of current IBR policies. 7 
Contact: 

Rajeev Darolia, PhD 

Wendell H. Professorship of Public Policy 

Associate Professor of Public Policy & Economics 

University of Kentucky 

859-323-7522 

Rajeev.Darolia@uky.edu 

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