Student Loan Interest Capitalization
Capitalization is the addition of interest to your principal balance. When interest is added to your principal balance, you are charged interest on that interest (compounding interest), thereby increasing your total loan costs.
There are specific events that trigger the capitalization of student loan interest:
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Your goal is to minimize the number of times capitalization occurs during student loan repayment
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Changing Loan Status
You can confirm the loan status for each student loan when you are logged into your account at STUDENTAID.GOV. Generally, when you are enrolled in school at least half-time, your loan status will be “in-school” or “deferred.”
When you finish school or are no longer enrolled at least half-time, and you have exhausted your six-month grace period, your loans will automatically change to “repayment” status. When you enter repayment, any unpaid interest you have from school will capitalize to create your starting loan repayment balance.
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Starting Repayment Balance = Amounts borrowed + Accumulated interest during school and grace period
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Deferment or forbearance are sometimes used to postpone your scheduled loan repayment while enrolled in advanced education (internship, residency, master's, or Ph.D. programs), or during periods of economic hardship. Deferment is a normal student loan status during veterinary school, however, you will continue to accrue interest on your unsubsidized and PLUS loans while in deferment. When you exit deferment or forbearance, any unpaid interest that is not paid will be capitalized. Periods of academic deferment or forbearance do not count toward repayment periods.
During veterinary school, student loan deferment is good. After veterinary school deferment or forbearance periods are not helpful. Thankfully, after you're done with school, deferment or forbearance is no longer necessary. The income-driven repayment plans have made deferment and forbearance obsolete for veterinarians. You will save yourself significant cost and repayment time using IDR over a deferment or forbearance. When you defer your loans, not only does interest accumulate that will be capitalized when you exit deferment and re-enter repayment, but you also extend the time that you have to deal with your loans.
For example, let’s say you borrow $200,000 for school and graduate in 2022. When you graduate and enter repayment after your grace period, you may have some additional in-school interest that will capitalize when you enter repayment. ***Although a lower amount of interest than otherwise would capitalize due to the pandemic forbearance benefits that started March 13, 2020***. Let's say that the in-school unpaid interest amount is $10,000. When you enter repayment after school, your starting repayment balance will be $210,000. If you choose an IDR, your starting repayment balance could remain constant at that level or decrease for the duration of repayment.
Alternatively, if you defer your loans during an internship or if you were to take family leave, you will accumulate interest on your $210,000 starting repayment balance at 5.5%. That is about $11,550 of additional interest for the year. If you start repayment after your internship or family leave, your new starting repayment balance will be $221,550 for the duration of repayment. If you do a second internship or residency, you can add an additional year of interest for each year you defer, increasing the amount of compound interest that accrues during repayment.
If you keep your loans in an income-driven plan, you will only accrue interest on your starting repayment balance. As long as you continue to provide timely income documentation, your unpaid interest will never again get added to your principal and you will earn forgiveness qualifying time for all periods you are using an income-driven plan.
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Colleagues don’t let other colleagues defer their loans. Utilize an income-driven repayment plan!
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Loan Consolidation
A federal Direct Consolidation Loan can be a useful tool for helping you get the most benefits out of your federal student loans and repayment strategy. The best time to utilize a Direct Consolidation Loan is as soon as possible after graduating from veterinary school. Once you're past your veterinary school grace period, a thorough analysis of your student loans and financial specifics will determine whether or not you should still pursue a Direct Consolidation. Here is what a federal Direct Consolidation Loan can do:
- Help older loans qualify for some of the newer repayment plans, like Pay As You Earn (PAYE) and Revised Pay As You Earn (REPAYE) or Public Service Loan Forgiveness.
- Help non-Direct Loans like Health Professions Student Loans (HPSL), Loans for Disadvantaged Students (LDS), and Perkins Loans benefit from income-driven repayment plans.
- End your grace period early to help you start earning forgiveness qualifying credit sooner and secure the lowest possible student loan payment using an income-driven plan for the first 12 months after school.
- Choose a new loan servicer, like MOHELA, to help with your student loan repayment strategy going forward
People often worry about consolidating lower interest rates loans with their higher interest rate loans. When you consolidate, the Dept of ED will calculate a weighted average interest rate for your newly consolidated loan. The resulting interest accrual will be the same on your consolidation loan as it would have been across all of your loans had you not consolidated your loans. There is very little benefit to paying off smaller balances, higher interest rate loans, or leaving lower or higher interest rate loans outside of your consolidation. For maximum simplification, include all eligible federal student loans in your Direct Consolidation Loan. For more detail on the best repayment strategy for new graduate veterinarians, review the annual Student Loan Repayment Playbook resources.
Failing the Partial Financial Hardship (PFH) Test Under Certain IDR Plans
When you submit your annual income documentation for Income-Based Repayment (IBR) or PAYE, there is a PFH test to see if your current minimum monthly payment under IBR or PAYE is less than your standard 10-year repayment amount when you first entered repayment. If you pass the test, then your payment amount will be calculated based on our income and no capitalization will occur.
However, if you no longer demonstrate a PFH, then your minimum monthly payment will be equal to the standard 10-year repayment amount when you entered repayment and unpaid interest will be capitalized.
Under IBR, all of your unpaid interest is capitalized when you no longer demonstrate a PFH. Under PAYE, only an amount equal to 10% of your starting repayment balance will be capitalized. Any remaining interest will remain as unpaid interest in your loan account.
REPAYE does not have a PFH test. As long as you continue to provide annual income documentation, no unpaid interest will capitalize under REPAYE and your minimum monthly payment will always be 10% of your discretionary income.
Failing to Provide Annual Documentation for an IDR Plan
In order to continue having your minimum monthly payment based on your income, you must provide timely annual income documentation. If your loan servicer does not receive the adequate documentation in time:
• Under IBR, all of your unpaid interest will capitalize and your repayment amount will be the standard 10-year amount when you entered repayment.
• Under PAYE, only an amount equal to 10% of your starting repayment balance will be capitalized. Any remaining interest will remain as unpaid interest in your loan account and your repayment amount will be the standard 10-year amount when you entered repayment.
• Under REPAYE, all of your unpaid interest will be capitalized and you will be placed in an alternate repayment plan that is calculated to ensure your loan is paid in full based on the number of years you have remaining in REPAYE.
In order to get back into compliance for your IDR, you need to provide adequate income documentation. At that point, you can again have your minimum monthly payment calculated based on your income and receive credit for the time you paid a standard 10-year or alternate plan amount towards the maximum repayment periods and forgiveness. The only exception is that payments made under the alternate program in REPAYE will not count towards PSLF if you are working for a qualifying employer.
The easiest way to avoid any of this messiness is to set a calendar reminder each year and provide timely income documentation to your loan servicer, either directly or via studentaid.gov.