What Is Payment Deferral?
Payment deferral is a financial arrangement that allows a borrower to temporarily postpone scheduled payments on a loan or debt. This mechanism falls under the broader category of personal finance and debt management, offering a reprieve to individuals or entities facing financial hardship. During a deferral period, the borrower is not required to make regular payments, providing temporary relief and the opportunity to stabilize their budget or cash flow. The terms of a payment deferral, including whether interest continues to accrue, are determined by the lender and the specific type of loan.
History and Origin
While the concept of postponing payments has existed informally for a long time, formalized payment deferral programs gained significant prominence during economic downturns and crises. A notable recent example is the widespread implementation of payment deferral options during the COVID-19 pandemic. In response to the unprecedented financial disruption, governments and financial institutions introduced programs to help individuals and businesses manage their debts. For instance, the U.S. government, through legislation like the CARES Act, enabled borrowers with federally-backed mortgages to request forbearance (a form of payment deferral) for an initial period, with options for extension. Similarly, federal student loan payments were automatically paused with a 0% interest rate for an extended period, providing substantial relief to millions of borrowers.20, 21 The Consumer Financial Protection Bureau (CFPB) also issued interim rules to facilitate mortgage servicers offering COVID-19 payment deferral options, removing potential barriers for lenders.19
Key Takeaways
- Payment deferral temporarily pauses a borrower's obligation to make scheduled loan or debt payments.
- It is typically offered by lenders in situations of financial difficulty or during widespread economic crises.
- While payments are paused, interest may continue to accrue on the outstanding principal, increasing the total cost of the loan over its lifetime.
- Payment deferral can help prevent default and negative impacts on a borrower's credit score if managed properly.
- The deferred amounts usually need to be repaid later, often by extending the loan term or through a lump sum.
Interpreting the Payment Deferral
Interpreting a payment deferral primarily involves understanding its implications for the overall cost and duration of the debt. While deferral provides immediate relief from monthly obligations, it does not erase the debt. For many types of loans, such as auto loans and unsubsidized student loans, interest continues to accrue during the deferment period.17, 18 This accumulated interest may be added to the loan balance (capitalized) once payments resume, leading to a higher total amount to be repaid and potentially larger future payments. Therefore, a borrower should evaluate the terms of the payment deferral carefully, considering how the paused payments will be handled and the impact on their long-term repayment plan.
Hypothetical Example
Consider Sarah, who has a $20,000 personal loan with a 5% annual interest rate and a 5-year repayment term. Due to an unexpected medical emergency, she faces temporary financial hardship and requests a three-month payment deferral from her lender. The lender approves the request, noting that interest will continue to accrue during this period.
Normally, Sarah's monthly payment might be around $377. Over the three-month deferral, interest continues to accumulate. If approximately $80 in interest accrues each month, her total accrued interest during the deferral period would be $240. When her payments resume, this $240 in accrued interest might be added to her principal balance, or she might be required to pay it off separately. In either case, her total cost of the loan will increase, and her subsequent monthly payments might be slightly higher or her loan term extended to account for the deferred amounts. This example highlights the importance of understanding the terms and conditions of a payment deferral.
Practical Applications
Payment deferral is a common tool in various financial sectors, offering flexibility to borrowers during periods of strain.
- Mortgages: During economic crises or individual financial hardship, mortgage payment deferrals (often in the form of forbearance) can prevent foreclosure. For instance, the U.S. Department of the Treasury's Homeowner Assistance Fund (HAF), established by the American Rescue Plan Act, provides financial assistance to homeowners impacted by COVID-19, which can include mortgage payment assistance.15, 16
- Student Loans: Student loan deferment is common for borrowers enrolled in school at least half-time, experiencing unemployment, or facing economic hardship. Federal student loans, in particular, often have specific deferment options provided by the U.S. Department of Education.14
- Auto Loans: Many auto lenders offer loan extensions or postponements, which are types of payment deferrals, to borrowers struggling to make car payments.13
- Credit Cards and Personal Loans: While less common than for secured loans, some credit card companies and personal loan providers may offer temporary payment deferral options, though interest almost always continues to accrue.12
These applications underscore payment deferral's role in debt management and its potential to avert more severe financial outcomes like bankruptcy.
Limitations and Criticisms
Despite its utility, payment deferral has limitations and can draw criticism, primarily concerning the accrual of interest and the eventual repayment obligation. A significant drawback is that while payments are paused, interest often continues to accumulate on the outstanding balance.9, 10, 11 This means that although immediate financial pressure is relieved, the total cost of the loan increases, and the borrower may end up paying more in the long run. As the Sacramento Bee reported, "deferring your loans can have other consequences for your finances. For example, depending on the type of loan, it may continue to accrue interest while it's deferred. That means you'll end up paying more money in the long run."8
Furthermore, payment deferral does not equate to debt forgiveness; the deferred amounts must still be repaid.7 The methods for repayment—whether through a lump sum, increased future payments, or an extended loan term—can sometimes pose a new challenge to borrowers once the deferral period ends, potentially creating another cycle of financial stress if not carefully planned. Critics also point out that while deferral itself generally doesn't harm a credit report, the underlying financial instability that led to the deferral could still affect future lending decisions.
##6 Payment Deferral vs. Forbearance
While often used interchangeably, payment deferral and forbearance are distinct terms, though both allow for a temporary pause in loan payments. The primary difference often lies in how interest is treated and the specific conditions for qualification.
- Payment Deferral: In a typical payment deferral, interest may or may not accrue during the pause, depending on the loan type and terms. For instance, some federal subsidized student loans do not accrue interest during deferment, while unsubsidized loans do. The5 deferred payments are usually added to the end of the loan term or repaid in a lump sum later.
- Forbearance: Forbearance almost always involves the accrual of interest during the pause, regardless of the loan type. This accrued interest is typically capitalized (added to the principal balance) when payments resume, increasing the overall debt. Forbearance is often granted due to immediate financial distress, and the repayment options at the end of the period can vary, including a lump sum, a repayment plan, or a loan modification.
The key point of confusion is that forbearance is a specific type of payment deferral, but not all payment deferrals are forbearance. When seeking to postpone payments, understanding these distinctions is crucial, as the financial implications can vary significantly. A borrower should always clarify with their lender the precise terms, especially regarding interest accrual and repayment.
FAQs
Q: Does payment deferral hurt my credit score?
A: Generally, no. When a lender approves a payment deferral, they report the paused status to credit bureaus without negatively impacting your credit score, as long as you were current on payments when the deferral was granted. In 3, 4fact, deferring payments can prevent late payments or defaults, which would harm your credit rating.
Q: Will I still be charged interest during a payment deferral?
A: It depends on the type of loan and the terms of your deferral agreement. For many loans, such as unsubsidized student loans, auto loans, and personal loans, interest will continue to accrue during the deferral period. For1, 2 some federal subsidized student loans, interest may not accrue. Always confirm with your loan servicer.
Q: What happens when the payment deferral period ends?
A: At the end of the deferral period, you will typically need to resume making regular payments, and the deferred amounts will need to be addressed. This could involve extending the loan term, increasing your future monthly payments, or making a lump-sum payment of the deferred amount plus any accrued interest. Your lender will usually discuss these options with you.