An additional charge added to an original principal loan amount because the borrower has not made the adequate payments

This situation occurs both when the borrower has made some but not adequate payments and when no payments have been made at all. Essentially this means that the borrower is paying interest on interest. Companies treat this interest as an asset and amortize it over time through the income statement.

Capitalized interest is created by student loans as well. If it is unsubsidized, the borrower of a student loan may defer interest payments, therefore capitalizing the interest. Deferment results in the increase of the principal on the loan and, as a result, the payments owed after the deferment period. Because this increases the total amount paid on the loan significantly, it is suggested that a student not choose to do this unless it is absolutely necessary.