You might have heard of instances with loans where you can pay the interest at a later time than when you would’ve had to normally. In such cases, lenders agree to defer the interest payments on the loan. It’s just “when”, and not “if”. You owe the money and you have to pay it.
Lenders advance loan to individuals and businesses. The former use this money as funds for the purchase of an asset or such. With individuals the amount is most commonly for funding their activities. A business finds it practically difficult to repay the loan during an unproductive period, which is when they resort to deferred repayment so that they do not have to expend the amount. It can accumulate the loan interest on the principle balance, and capitalize the interest until the asset purchased is put to productive use. This adds to the cost of the asset though, and the asset value increases, and that can be written off during the life of the asset. These are the pros and cons of capitalized interest on business.
When you defer interest payments while a on loan, interest accrues on the loan balances, and you will have to pay interest on the accumulated interest too. This is beneficial for the lender, as they can take a higher interest and higher repayment amounts when the repayment time arises. Still, they have to bear with not getting the interest payment currently.
A capitalized interest student loan is a prime example of this, and such is most commonly drawn as a loan for student education. The repayment of interest on these loans is waived up until the individual completes his education and starts earning an income. During the period of study the lenders send over statements of the interest, instead of collecting on it right away.
The cons for a capitalized interest student loan are more than those for the one a business draws. For example, extension of the period of loan by not completing the studies in the stipulated period will attract more interest for it. When the student starts repayment it is first set off against current interest and then towards accumulated interest, and only then against the principle amount. Therefore, the principle balance remains the same for long.
You should remember that by deferring interest payment, you owe more money to the lenders towards the end. This is why it’s best just to go for the normal repayment option, though people have their own preferences.