It is increasingly common for individuals to borrow money to finance a college education, purchase a home or even make day-to-day purchases. Each time money or credit is extended, a borrower must agree to specific repayment terms. These terms often include a financial penalty for late payments or delinquency, which can result in capitalization fees.
The amount of money that an individual borrows is referred to as the loan principal. This is the amount of money that is repaid to a lender if the loan is interest fee or repaid within a specified time. If you use your credit card to make a purchase, your credit company gives you a certain amount of time, usually between 25 and 30 days, to repay the money borrowed without any interest or fees.
Interest is usually considered an unavoidable cost of borrowing money, and many types of loans automatically include it. When an individual takes out a student loan or home mortgage, the agreement that he makes with his lender usually includes the repayment of both loan principal and interest. If you have a mortgage, you are required to make monthly interest and principal payments in accordance with your loan terms. In contrast, many student loans allow a student to defer paying interest while in school and for up to six months after graduation.
If a student or credit card holder fails to make the required payment on his loan in a timely manner or makes only the minimum repayment amount, the interest or fees on the loan may accumulate. When loan fees and interest accumulate, they become capitalized, or a part of the principal balance of the loan. These capitalized fees subsequently begin to accrue interest just as the original loan principal did. Over time, this can significantly increase the outstanding loan balance.
The higher the amount of your loan, the greater the impact of capitalized fees. The longer it takes you to pay back a loan, the higher the rate of fee capitalization. To avoid capitalization fees, credit card users should always pay the full balance on their credit card at the end of each billing period. Likewise, individuals with student loans should make every effort to pay at least the interest on their loan, if not the actual principal.
Sophia Harrison began writing professionally in 2007. She has a Master of Arts in economics from the University at Buffalo-SUNY, as well as experience working in the New York City financial industry.