I have two unsubsidized, graduate student loans, both with the same company. They are currently in deferment since I am still a student, and will remain so for at least another year. However, I am working and making payments towards them. I am a little confused about how the capitalization of the interest works.

From what I am reading online, it seems like as long as I am in deferment, I only accrue interest on the principle amount, and not on the interest already accrued. So if I have a $10,000 loan, with a 6.8% interest rate, I will accrue $680 worth of interest every year, until that interest is capitalized into principle (as opposed to accruing $680 worth interest in the first year, and then ($10,000 $680)*6.8%=$726.24 in the second year). Is this correct? If so, I think this has big implications on how I should allocate my payments.

Like I said, I have two unsubsidized loans with the same company. For simplicity, lets say the principle balance on both is $10,000, and each have accrued $2000 worth of interest so far. I want to put $1000 every month towards these loans. When I make a payment, the payment goes towards the accrued interest first. Once that is paid down, it then goes towards the principle. If what I said above is true, then my accrued interest is not earning any interest (it is not capitalized), and it therefore behooves me to work my way towards the principle as quickly as I can, so I can slow the rate that I am accruing interest. Therefore, since I can choose which loan my payment goes to, I should put 100% of it towards one of the loans. I can therefore dig my way through the interest more quickly, and after 2 months or so of making $1000 payments, I will start paying off principle. As I pay down the principle, I accrue less interest, and the total amount that I end up having to pay back is reduced.

If, instead, I had put 50% of my payment towards each loan ($500 to each), it would take me more than twice as long to get to the principle, so I would be accruing additional interest over that time.

Is my logic here correct? I have not seen anywhere that talked about it, so I am wondering if I am missing something important. If not, this would seem like a really useful piece of knowledge for people paying back student loans while in deferment.