Capitalization is the addition of unpaid interest to the principal balance of a loan. When interest is not paid as it accrues during periods of non-payment (such as in-school status, a grace period, deferment or forbearance), a borrower’s lender may capitalize the interest. This increases the outstanding principal amount due on the loan and may cause monthly payment amounts to increase. Interest is then charged on that higher principal balance, increasing the overall cost of the loan.