Loan Deferment: Definition, Example, and FAQs
Loan deferment is a temporary postponement of loan payments. During a period of loan deferment, the borrower is generally not required to make payments on the principal of the loan. In some cases, depending on the type of loan, interest may also be suspended, or the government may pay the interest on behalf of the borrower. This financial strategy falls under the broader category of debt management, offering borrowers a way to alleviate financial strain during specific qualifying circumstances. Loan deferment differs from other forms of payment relief in how interest accrues and how the missed payments are handled.
History and Origin
The concept of temporarily postponing loan payments has evolved significantly, particularly within the realm of government-backed loans designed to support specific public policy goals, such as access to education. Early forms of student loans, like those offered under the National Defense Education Act of 1958, introduced mechanisms for borrowers to pause payments under certain conditions.
The widespread availability of loan deferment for federal student loans expanded with various legislative acts. For instance, deferment options became a standard feature, allowing students to postpone payments while enrolled in school at least half-time, during periods of unemployment, or economic hardship. More recently, during the COVID-19 pandemic, broad payment pauses were implemented for federal student loans, effectively acting as an automatic deferment period for millions of borrowers, with interest rates set to 0% and collection activities suspended. This provided substantial economic relief. The U.S. Government Accountability Office (GAO) has frequently reviewed these repayment options, assessing their impact and communication to borrowers.12 Similarly, during economic downturns or natural disasters, mortgage lenders and government-sponsored enterprises like Freddie Mac have offered payment deferral solutions to homeowners facing temporary financial hardship, enabling them to avoid foreclosure.11
Key Takeaways
- Loan deferment allows a borrower to temporarily stop or reduce loan payments for a specified period.
- Eligibility for loan deferment often depends on specific circumstances, such as enrollment in school, unemployment, economic hardship, or military service.
- For some types of loans, particularly subsidized federal student loans, the government may pay the interest that accrues during the deferment period.
- If interest is not subsidized, it may continue to accrue and be capitalized (added to the principal balance) at the end of the deferment, increasing the total amount repaid.
- Deferment can help borrowers avoid delinquency and protect their credit score during periods of financial hardship.
Interpreting Loan Deferment
Loan deferment is interpreted as a temporary relief measure that provides borrowers with a structured pause from their obligation to make regular payments. When a loan is in deferment, the borrower's account status reflects this pause, meaning payments are not considered past due, and negative reporting to credit bureaus is avoided. This is a critical distinction from simply missing payments, which would negatively impact a borrower's credit standing.
The primary benefit lies in managing liquidity during challenging times. For instance, a borrower pursuing higher education might utilize an in-school deferment to focus on studies without the immediate burden of student loan payments. Understanding the terms of the deferment, particularly regarding interest accrual and capitalization, is crucial for borrowers to grasp the total cost implications. A borrower's loan servicer typically provides details on how interest will be handled during and after the deferment period.
Hypothetical Example
Consider Sarah, who has a federal student loan with a remaining balance of $30,000 and an interest rate of 5%. After graduating, she secures a job, but six months later, she decides to pursue a master's degree full-time. Recognizing that her income will decrease significantly, she applies for an in-school loan deferment.
Her federal student loan is a Direct Subsidized Loan. During the deferment period while she is enrolled at least half-time, the government pays the interest that accrues. If her deferment lasts for two years, she would not make any payments, and her loan principal would remain $30,000, as no interest accrues for her to pay. After completing her master's degree, she would typically have a grace period before her payments resume, at which point her new repayment plan would be based on the original $30,000 principal balance. This allows Sarah to manage her finances effectively while investing in her education without the added pressure of immediate loan payments.
Practical Applications
Loan deferment is commonly applied in several financial sectors, primarily for student loans and mortgage loans.
- Federal Student Loans: The U.S. Department of Education provides various deferment options for federal student loan borrowers, including in-school deferment, unemployment deferment, economic hardship deferment, and military service deferment. These options allow eligible borrowers to pause payments during specific life events without entering default. Borrowers can typically apply for deferment through their loan servicer.10
- Mortgages: While less common than for student loans, mortgage deferment or "payment deferral" programs exist, particularly in response to widespread economic crises or natural disasters. These programs allow homeowners to postpone a certain number of missed payments to the end of their loan term, or when the property is sold or refinanced. Freddie Mac, for example, offers payment deferral solutions to help homeowners resolve delinquencies.9 The Consumer Financial Protection Bureau (CFPB) also provides resources and guidance on mortgage relief options, including those related to temporary payment pauses.8 These programs aim to prevent widespread foreclosures and support economic stability during challenging times.
Limitations and Criticisms
While loan deferment offers significant relief, it comes with limitations and potential drawbacks. A primary concern is the accrual of interest. For unsubsidized loans (like Direct Unsubsidized Loans or Direct PLUS Loans) and most private loans, interest continues to accrue during the deferment period. This accrued interest may be capitalized, meaning it's added to the loan's principal balance when the deferment ends.7 Capitalization increases the total amount owed and the total cost of the loan over its lifetime, as future interest is then calculated on a higher principal.
Another criticism is that deferment only postpones the inevitable. Borrowers must eventually resume payments, often on a larger balance if interest was capitalized. This can lead to higher monthly payments or a longer repayment period. Additionally, eligibility for loan deferment is typically tied to specific qualifying events, meaning it's not a universal option for all financial difficulties. A study evaluating mortgage policies during the COVID-19 pandemic noted that while widespread forbearance (which shared characteristics with deferment) was effective in reducing foreclosures, nearly half a million borrowers who entered these programs still remained behind on their mortgages, with some entering foreclosure.6 This highlights that while helpful, deferment is a temporary measure and doesn't solve underlying long-term financial instability.
Loan Deferment vs. Loan Forbearance
Loan deferment and loan forbearance are both temporary postponements of loan payments, but they differ primarily in how interest is handled and the criteria for eligibility.
| Feature | Loan Deferment | Loan Forbearance |
|---|---|---|
| Interest Accrual | For some loans (e.g., subsidized federal student loans), interest may not accrue or may be paid by the government. For others, it accrues.5 | Interest typically accrues on all loan types.4 |
| Capitalization | Accrued interest may be capitalized at the end of the period for unsubsidized loans.3 | Accrued interest is typically capitalized at the end of the period.2 |
| Eligibility | Often tied to specific, defined circumstances (e.g., in-school enrollment, unemployment, economic hardship, military service). | Granted at the discretion of the loan servicer or lender, often for broader financial difficulties not covered by deferment criteria. |
| Legal Right | Borrowers often have a legal right to deferment if they meet specific criteria. | Generally, a lender's option, not a borrower's right, unless mandated by specific legislation (e.g., CARES Act for mortgages during COVID-19). |
The key distinction for many borrowers, especially with federal student loans, is whether interest is subsidized during the pause. If a borrower qualifies for a deferment where interest does not accrue, it is generally the more financially advantageous option compared to forbearance, where interest almost always continues to accumulate.
FAQs
Q: What types of loans offer deferment?
A: Loan deferment is most commonly available for federal student loans, including Direct Subsidized Loans, Direct Unsubsidized Loans, and Perkins Loans. Some mortgage programs, especially those backed by government-sponsored enterprises like Fannie Mae or Freddie Mac, may also offer payment deferral solutions. Private loans may offer similar options, but they vary greatly by lender and loan agreement.
Q: Does deferment affect my credit score?
A: No, if granted and managed correctly, loan deferment should not negatively impact your credit score. During deferment, your payments are paused, and your loan remains in good standing. This differs from missing payments, which would result in delinquency and negative credit reporting.
Q: Do I have to pay interest during deferment?
A: It depends on the type of loan. For federal student loans, such as Direct Subsidized Loans and Perkins Loans, the government typically pays the interest that accrues during deferment. For other federal loans (like Direct Unsubsidized Loans and PLUS Loans) and most private loans, interest continues to accrue, and you are responsible for paying it. If you don't pay the interest as it accrues, it may be added to your principal balance (capitalized) when the deferment ends, increasing your total debt.1