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How Interest Is Capitalized
Let’s take a look at some examples to see how interest is capitalized:
Assume you have taken out a $3,000 loan at 6% APR. Let’s further assume that for one reason or another, you don’t make a payment during the first month of the loan. What happens?
Let’s do the math, first let’s figure out the interest:
6% of $3,000 is $180 (annual interest)
Now keep in mind that this is the annual (yearly) interest; since it’s only been one month, we need to divide that interest by 12 to get the monthly interest due. So:
$180 (annual interest) / 12 = $15 (monthly interest)
The amount of interest which accrues at the end of the month is $15.
So since the month has ended, we capitalize the interest by adding it to the original amount owed:
$3,000 (balance owed) + $15 (monthly interest) = $3,015 (new balance owed)
The new balance owed on our loan at the end of the month is $3,015!