Question:

What is capitalization of interest cost?

Answer:

Capitalization of interest cost occurs when a lender adds the accrued interest to the principal and interest begins to accrue on the increased principal amount. Different lenders can have different interest capitalization policies and if you don't read carefully about capitalization, you could end up paying thousands of interest more than necessary. The capitalization of interest cost increases every time interest is capitalized (that is, interest is added towards the principal).

With mortgage loans capitalization of interest may or may not take place, depending on how the lender has decided to deal with it. Loans often have a minimum payment interest option, with which borrowers pay only part of the interest of the loan. The difference between a minimum and interest only payment will be added to the principal.

Some lenders will capitalize the interest and will ask you to repay the new mortgage balance with interest accruing on the new loan amount; others will spread the unpaid interest over your normal loan payments. The second option is of greater benefit to borrowers, as interest capitalization cost is smaller.

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