Quick answer
Capitalised interest is interest that isn't paid as it falls due but is added to the loan balance instead. The borrower makes no interest payments during the period, but each month's interest is then charged on a larger balance, so the total cost grows. It's common in bridging loans, construction and development finance and some short-term property-secured loans, where the whole debt is repaid from a sale or refinance.
Key points
- No interest repayments during the period: the balance grows instead
- Interest is then charged on the interest, so the total cost rises over time
- Used where income arrives later, such as a property sale or project completion
- Lenders reserve room within the loan limit or LVR to cover the growing balance
When interest is capitalised, the lender doesn’t ask you to pay it each month. It adds the unpaid amount to what you owe and collects everything at the end of the loan, usually from a sale or a refinance.
How does capitalised interest work?
At each interest date, usually monthly, the lender calculates the interest owing and adds it to the principal. Next month’s interest is worked out on that higher figure. Over a long enough period, you end up paying interest on interest.
Lenders know the balance will climb, so they plan for it. With construction and development finance, part of the facility limit is set aside as an interest allowance. With bridging and other short-term property loans, the lender leaves headroom under its maximum loan-to-value ratio so the balance at the end still fits.
Capitalised, prepaid or serviced: what’s the difference?
| Method | When you pay the interest | Monthly repayments | Effect on balance |
|---|---|---|---|
| Serviced (monthly) | As it falls due | Yes | Balance stays the same on an interest-only loan |
| Prepaid | Upfront, taken from the advance | No | Less cash in hand on day one |
| Capitalised | At the end, when the loan is repaid | No | Balance grows each period |
Worked example: a 12-month development loan
A builder in Brisbane borrows $500k to finish a pair of townhouses, with the debt to be repaid from the sales. Assume the interest for the first month comes to $5,000.
If the builder pays the interest monthly, it’s $5,000 every month, or $60,000 over a year, and the balance stays at $500k.
If the interest is capitalised, month one’s $5,000 is added, so month two’s interest is charged on $505,000 and comes to $5,050. By month twelve, the monthly charge has crept above $5,500. The year’s interest totals about $63,400, and the builder owes roughly $563,400 when the townhouses sell.
That extra $3,400 or so is the price of not paying along the way. For a project that earns nothing until settlement, it can be worth it, but if the sales drift three or four months past plan, the balance keeps compounding. Our loan cost comparison calculator helps you see the gap for your own figures.
Weighing up a loan where interest builds up rather than being paid monthly? Tell us about the project and we’ll help you size it.
Why it matters in business lending
Capitalising suits loans with a clear repayment event and little income in the meantime: bridging finance, development, land banking and some caveat loans. It’s a poor fit where the business has steady income, because paying as you go is cheaper.
The real risk is delay. A lender that approved the loan on a twelve-month timeline may not let the balance keep growing indefinitely. Once the interest allowance is used up, you may be asked to start paying monthly, put in more cash, or refinance. Default interest can also be capitalised if a loan runs past its expiry, and that adds up quickly.
Related terms
See loan-to-cost ratio, which development lenders use to cap the facility including the interest allowance, and progress draw, the staged release of construction funds. Our guide to what capitalised interest means for you looks at the tax and strategy side in more depth.
Need a loan that waits for your payday?
If your money arrives at the end of a project or sale, a loan with capitalised interest can bridge the wait without straining monthly cash flow. Getting started is a sixty-second form, and enquiring doesn’t touch your credit rating. Your details go to us alone. Someone familiar with property-backed finance reviews them and phones you, rather than your number ending up with a dozen funders. Be accurate about your timeline and the expected sale or refinance figure, so we can line up a lender with enough headroom first time.
Frequently asked questions
Is capitalised interest the same as interest-only?
No. With an interest-only loan you pay the interest each month and the balance stays the same. With capitalised interest you pay nothing during the period and the unpaid interest is added to the balance, which therefore grows.
Is capitalised interest the same as prepaid interest?
No. Prepaid interest is paid upfront, usually deducted from the loan advance at settlement, so you receive less cash on day one. Capitalised interest is paid at the end, when the loan is repaid. Both remove monthly repayments, but the cash flow and total cost differ.
Why would a lender agree to capitalise interest?
When the borrower's income from the asset only arrives at the end, as with a development that earns nothing until units sell, monthly payments would be hard to meet. Capitalising lets the loan match the timing of the repayment event, as long as there's enough security to cover the growing balance.
Can capitalised interest be claimed as a tax deduction?
The tax treatment depends on what the loan is used for, the structure, and whether interest is incurred on business borrowings. The ATO has issued rulings on interest charged on capitalised interest in particular arrangements, so ask your accountant before assuming a deduction.
How do I keep capitalised interest under control?
Keep the term as short as is realistic, repay early if the sale or refinance comes through ahead of time, and check whether early repayment carries fees. Ask the lender how often interest is added, because more frequent capitalisation compounds slightly faster.