UNITED STATES DEPARTMENT OF EDUCATION
OFFICE OF POSTSECONDARY EDUCATION
Issue Paper #3: Interest Capitalization
Session 1: October 4-8, 2021
Issue:
Statutory cites:
Regulatory cites:
Eliminate interest capitalization for non-statutory capitalizing events
§428H(e)(2) of the Higher Education Act of 1965, as amended
34 CFR 685.209(a)(2)(iv), 685.209(c)(2)(iv), 685.202(b)(4), 685.202(b)(3), and
685.220(f)(3)
Summary of issues: Section 428H(e)(2) of the Higher Education Act of 1965, as amended, provides that
interest capitalization occurs when any accrued, unpaid interest becomes part of the principal balance
of a borrower’s loan. Capitalization is triggered by designated “capitalizing events.” Once interest is
capitalized, it begins to accrue interest at the rate applicable to the loan. This ultimately increases the
overall balance of the loan and typically increases the amount the borrower must repay. When
capitalization occurs, borrowers see balances rise faster as interest accrues on interest.
Interest capitalization is not a common practice across other consumer financial products, at least in
part because Federal student loans afford more opportunities to pause or reduce payments. Auto loans
do not provide common occurrences for interest capitalization. Mortgage interest typically only
capitalizes with certain modifications. In addition, there are federal and state laws that prohibit
capitalization of interest on certain consumer financial products and under certain circumstances. While
student loans are a very different kind of financial product, capitalization can be a frustrating experience
for borrowers who are confused as to what triggered the capitalization or surprised by the higher
amount owed.
The Department has identified the following capitalizing events in regulation where we are proposing to
eliminate interest capitalization on a more permanent basis:
•Failure to recertify enrollment on an income-driven repayment (IDR) plan — Borrowers are
required to recertify their participation in any income-driven repayment plan annually, but ED
data presented at a 2015 negotiated rulemaking session indicates that over half of borrowers
in an IDR plan fail to recertify on time. Additionally, researchers have suggested that
recertification is a significant barrier for lower income borrowers.1
•Leaving an Income-Contingent Repayment (ICR) plan (PAYE, REPAYE, ICR) — While borrowers
switching across other types of repayment plans, such as standard and graduated, do not have
their interest capitalized, ICR borrowers do.
1 https://www.urban.org/urban-wire/structural-changes-student-loan-repayment-could-make-forgiveness-work-
better-struggling-borrowers
