Interest charges on deferments and forbearances are often unnecessarily confusing.
Many lenders and loan servicers are guilty of making it look like a payment pause is interest-free when the borrower’s balance actually grows.
This article will cover the times a forbearance or deferment is truly interest-free. We will also look at strategies for borrowers chasing PSLF, credit score implications, and more.
General Rule: Even if you don’t have to make payments, interest accrues
The vast majority of forbearances and deferments charge interest.
For this reason, many lenders make it relatively easy for borrowers to get a deferment or forbearance. A six-month to one-year payment pause is often easy to get.
The problem with this relief is that it is temporary. Worse yet, each deferment or forbearance usually makes things worse. By not making payments, the balance grows. The larger balance means more debt to eventually pay off. It may also mean higher monthly payments.
An income-driven repayment plan is usually the best option for borrowers struggling with federal loans. IDR payments count towards student loan forgiveness, and borrowers may qualify for $0 monthly payments for many years.
Sherpa Tip: Sometimes, people get confused about the interest charges because balances don’t immediately reflect the daily interest that the loan generates.
This extra interest usually sits off to the side until the interest gets capitalized. Many billing statements and invoices do not make this detail clear.
What is the difference between a Deferment and a Forbearance?
I’m often guilty of using the terms deferment and forbearance interchangeably.
In most cases, there isn’t much of a difference. The strategy behind deferments and forbearances is usually the same. Likewise, both payment pauses usually charge interest.
However, interest charges are the one area where a deferment and a forbearance work differently.
Other than one notable exception, federal loan forbearances always charge interest. Conversely, a deferment sometimes charges interest.
Deferments where interest does not accrue
Whether or not you are charged interest during a deferment usually depends upon the loan type.
According to the Department of Education, the following federal loans generally do not accrue interest during a deferment:
- Direct Subsidized Loans
- Subsidized Federal Stafford Loans
- Federal Perkins Loans
- The subsidized portion of Direct Consolidation Loans
- The subsidized portion of FFEL Consolidation Loans
In other words, if your loan is a subsidized or a Perkins loan, you usually won’t get charged interest during a deferment.
All other federal loans get charged interest during a deferment.
The Exception to the Rule
The Covid-19 federal student loan payment suspension is technically an administrative forbearance. All federally-held student loans are on a forbearance with a 0% interest rate.
This is the one time that borrowers on a federal forbearance don’t accrue interest charges.
Are Private student loan deferments and forbearances interest-free?
With private loans, lenders almost always charge interest during a deferment or forbearance.
I use the term almost always because each private loan is governed by the terms of the loan contract that the borrower signed. It is conceivable that a private loan may have a provision where the borrower is not charged interest during a payment pause.
However, interest will accrue during all forbearances and deferments for the vast majority of private loan borrowers.
Making Interest-Only Payments During a Deferment or Forbearance
Sometimes it is a good idea to make a payment, even if it isn’t required.
Ultimately, whether or not you should make payments during a forbearance or deferment depends upon your debt-elimination strategy.
Interest-Only Payments During an In-School Deferment
I often advise students to make interest payments each month on all of their student loans.
This strategy is helpful because it encourages responsible borrowing during college. Many students are guilty of borrowing more student loans than necessary. Once school ends and they start receiving bills, they regret how much debt they incurred.
The students who make interest-only payments during school have a much better appreciation for the mountain of debt they are building. Each new loan means a new monthly payment. Students making interest payments will have a huge incentive to borrow less and to seek out low-interest loans. The monthly payment is also an excellent reminder of the importance of finding a job that pays well after school.
Interest-Only Payments for Borrowers After Graduation
The best student loan repayment strategies usually require borrowers to make minimum payments on all of their loans except one. The one loan targeted for elimination gets all available extra funds.
Borrowers who pay a little extra towards all of their loans often spend more than necessary on interest.
If your student loan repayment strategy calls for eliminating one specific loan first, don’t worry about making payments on a loan in deferment or forbearance.
For example, if you are attacking a private loan at 11% interest, it isn’t necessary to make payments on a deferred loan charging 6% interest. While the deferred loan balance is growing, which is bad, the loan with the 11% interest rate is doing more damage.
Managing Loans when a Deferment or Forbearance Ends
The most important thing to know about deferments and forbearances is that they are temporary fixes. Borrowers need to come up with a plan to eliminate their debt.
Additionally, it is a good idea to make sure that your contact information is up to date. As your payment pause comes to an end, your lender may send out important emails or letters. If you miss these messages, you risk late payments and negative credit reporting.
Finally, those who are enjoying a payment pause due to Covid should expect a mess once payment resumes in February 2022. Ideally, you should reach out to your servicer with any questions before the restart happens.
Deferment and Forbearance Interest Frequently Asked Questions
No. Unfortunately, most deferments charge interest, and there is nothing that a borrower can do to avoid these interest charges.
No. Borrowers often receive letters about unpaid interest during a deferment or forbearance, but making interest payments is optional. In many cases, not making a payment is the best strategy.
No. The general rule is that forbearances and deferments do not count towards forgiveness clocks. The only exception to this rule is the Covid-19 payment pause.
No. However, a payment pause will appear on your credit report. Potential creditors may have a problem calculating your debt-to-income ratio, and it could lead to a rejected application.