Deferment period

What Is Deferment Period?

A deferment period is a temporary postponement of loan payments. During this time, the borrower is not required to make payments on their loan principal and, in some cases, the interest that accrues. It is a common tool used within personal finance and loan management strategies, designed to provide relief to borrowers facing financial hardship or specific life events. Deferment periods are distinct from other forms of payment relief in how interest is treated, particularly with certain types of student loans.

History and Origin

The concept of postponing loan payments has evolved with the history of credit and lending. Formalized deferment periods, especially in the context of federal student aid, became prominent with the growth of government-backed educational financing. The initial federal student loan programs, such as those established under the National Defense Education Act of 1958, began to lay the groundwork for structured repayment and relief options. This act offered the first national student loans, eventually leading to programs like the Perkins Loan, and included early provisions for loan forgiveness based on certain services¹³. Over time, as educational costs rose and student loan programs expanded, the need for clearly defined periods of paused payments became more critical to help borrowers manage their debt during periods of economic instability or career development.

More recently, specific legislation has mandated deferment-like relief for broader populations. For instance, in response to the COVID-19 pandemic, the Coronavirus Aid, Relief, and Economic Security (CARES) Act provided significant temporary payment suspensions and zero-interest relief for most federal student loans and established rights to mortgage forbearance for federally-backed mortgages¹². This allowed millions of borrowers to temporarily pause their payments, highlighting the role of deferment periods as a critical financial relief mechanism during widespread crises.

Key Takeaways

• A deferment period allows a borrower to temporarily stop making payments on a loan.
• For certain types of loans, particularly subsidized federal student loans, interest does not accrue during a deferment period.
• Eligibility for a deferment is typically tied to specific circumstances such as enrollment in school, unemployment, economic hardship, or military service.
• Successfully completing a deferment period often requires the borrower to resume their repayment schedule or explore alternative payment plans.
• Unlike forbearance, some deferment periods prevent interest from growing on the outstanding principal balance.

Interpreting the Deferment Period

Understanding a deferment period involves recognizing its temporary nature and its impact on the total cost of a loan. While it offers immediate relief from monthly payments, the long-term implications vary significantly based on whether interest continues to accrue. For instance, if a loan is unsubsidized, interest will still accumulate during the deferment, leading to a larger total amount to be repaid. This accrued interest may also be subject to capitalization at the end of the deferment period, meaning it is added to the principal balance, and future interest will be calculated on this new, higher amount. Borrowers should always verify the terms of their deferment with their loan servicer to understand the financial consequences.

Hypothetical Example

Consider Maria, who has a federal subsidized student loan with an outstanding balance of $30,000 and an interest rate of 4%. After graduating, she struggles to find full-time employment and faces an "economic hardship" deferment period for six months. Because her loan is subsidized, no interest accrues during this deferment.

Here's how it plays out:

1. Original Loan: $30,000 at 4% annual interest.
2. Deferment Request: Maria applies for and is granted a six-month economic hardship deferment.
3. During Deferment: For six months, Maria makes no payments. Crucially, because it's a subsidized loan, her $30,000 balance does not accrue any interest.
4. After Deferment: When her deferment period ends, her loan balance remains $30,000, and she resumes her regular monthly payments.

If Maria's loan had been unsubsidized, interest would have continued to accrue during the deferment, adding to her total balance by the time repayment resumed.

Practical Applications

Deferment periods are primarily used in contexts involving personal credit and government-backed programs:

• Student Loans: This is one of the most common areas for deferment. Federal student loan borrowers may qualify for deferment while enrolled in school at least half-time, during a grace period after leaving school, during unemployment, or while experiencing economic hardship¹¹. Interest generally does not accrue on subsidized federal student loans during deferment¹⁰.
• Mortgages and Other Loans: While less common than for student loans, deferment might be offered for other types of loans, such as mortgages, in specific hardship scenarios or due to natural disasters. For instance, the CARES Act allowed borrowers with federally-backed mortgages to request a forbearance period, which shares characteristics with deferment in terms of payment pause⁹. These programs are often designed to prevent default and minimize the negative impact on a borrower's credit score.
• Military Service: Individuals serving in the military may be eligible for deferment on their loans during periods of active duty. This provides financial flexibility to those serving their country. Eligibility for deferment due to qualifying military service is a specific provision for federal student loans⁸.

Limitations and Criticisms

While deferment periods offer crucial relief, they are not without limitations or potential drawbacks. A primary concern is the accrual and capitalization of interest on unsubsidized loans. Even if payments are paused, the underlying debt continues to grow, potentially leading to a significantly larger balance by the end of the deferment. This can increase the total cost of the loan and extend the overall repayment timeline. For example, if a borrower consistently defers payments on an unsubsidized loan, the rising principal can make it much harder to pay off the loan in the long run.

Another criticism is that deferment, especially repeated use, can prolong the borrower's time in debt and delay progress toward financial freedom. Although it provides a temporary respite, it doesn't resolve the underlying financial issues that led to the need for deferment. Furthermore, while the CARES Act provided broad relief, the expiration of such programs can lead to significant repayment shocks for borrowers who have grown accustomed to paused payments⁷. Tax implications can also arise: while student loan interest can often be deducted, no interest paid during a deferment means no deduction can be claimed for that period⁶.

Deferment Period vs. Forbearance

The terms "deferment period" and "forbearance" are often confused because both allow borrowers to temporarily stop or reduce their loan payments. However, a key difference lies in how interest is handled.

In a deferment period, interest typically does not accrue on subsidized federal student loans. For unsubsidized loans, interest will still accrue. Eligibility for deferment is generally tied to specific qualifying events, such as being enrolled in school at least half-time, unemployment, or economic hardship⁵.

In forbearance, interest accrues on all types of federal student loans, both subsidized and unsubsidized⁴. Forbearance is typically granted for a shorter period and often requires less stringent eligibility criteria, sometimes granted at the discretion of the lender or loan servicer due to general financial difficulties. While forbearance provides payment relief, the accruing interest can lead to a larger loan balance over time, especially if that interest capitalizes when the forbearance ends.

Both options prevent the loan from going into default during the approved period, but deferment can be more financially advantageous for borrowers with subsidized loans due to the interest subsidy.

FAQs

What types of loans typically offer a deferment period?

Deferment periods are most commonly associated with federal student loans, where they can be granted for reasons like in-school enrollment, unemployment, economic hardship, or military service³. Some other loan types, such as mortgages, might offer similar temporary payment pauses under specific circumstances, often during times of widespread economic distress.

Does interest accrue during a deferment period?

It depends on the type of loan. For federal subsidized student loans, interest generally does not accrue during a deferment period. However, for unsubsidized federal student loans and most private loans, interest will continue to accrue during deferment, potentially increasing the total amount you owe when payments resume².

How do I apply for a deferment period?

To apply for a deferment, you typically need to contact your loan servicer and submit an application, along with any required documentation to prove your eligibility. Your loan servicer can provide specific forms and guidance based on your loan type and reason for deferment. Many servicers offer online application options¹.

Can a deferment period negatively affect my credit?

If properly applied for and approved, a deferment period should not negatively impact your credit score. Your loan status will typically be reported as "deferred" rather than delinquent, indicating that you are meeting your obligations by pausing payments under agreed terms. However, missing payments without an approved deferment or forbearance will harm your credit.

Is deferment the same as loan forgiveness?

No, a deferment period is not the same as loan forgiveness. Deferment is a temporary pause in payments, after which you are still responsible for repaying the entire loan balance, possibly including any accrued interest. Loan forgiveness, conversely, means that a portion or all of your loan debt is canceled under specific programs or circumstances, and you are no longer required to repay it.