Are you thinking about deferring your student loans for a few months?
While deferments and forbearances might initially seem like a smart choice, they often lead to more problems. In fact, there are only a couple of circumstances in which a typical deferment is a smart decision.
The primary problem with deferments and forbearances is that borrowers are charged interest during the break in payments, so their balance grows.
The big exception to the “deferments and forbearances are dangerous” guidance occurs when a borrower isn’t charged interest. For example during the Covid-19 payment pause and the more recent SAVE litigation pause, borrowers were not charged interest.
Reasons you may want a deferment:
- Planning a major purchase like a car
- You are saving for a down payment on a new home
- The holidays are coming up
- You don’t start your new job for a few months
- You expect a raise in a few months
- Summer vacation should not be interrupted by student loans
- You are looking for a job/a better paying job
The reason(s) most deferments and forbearances are a mistake
Taking a break from paying your student loans is a bad idea from a financial and psychological point of view.
Financially, it is a terrible idea because of all the interest involved.
It isn’t just that you are not reducing your balance, the problem is that your balance is growing each month. If you defer on your student loans because of a financial hardship, the debt is only going to grow. Your issues, like your interest, compound each month you choose not to pay.
Another way of viewing the danger of a deferment is to remember that most lenders prefer borrowers take deferments early in repayment.
Most student loans include a six-month grace period post-graduation, during which no payments are required, but interest continues to accrue. During this time, the balance of the loan just grows. Deferments and forbearances increase lender profits. The only time a lender doesn’t want to do a deferment or a forbearance is if they fear that the borrower will never be able to pay back the debt.
From a mental standpoint, getting a deferment or forbearance on your loan can create bad habits.
In the six months you are not paying your loan, you may grow accustomed to spending money you really don’t have. Breaking bad spending habits is especially hard to do. The other problem with deferment is that you may think in the back of your mind that it will always be an option. However, for most loans, deferments and forbearances are limited. If you run out, and you really need another, you are out of luck. Therefore, you should never plan on using them and treat them as an option only in case of an emergency.
The Interest Free Forbearance Exception
If the big risk to a forbearance is the daily interest charges, our analysis changes dramatically with a forberance that doesn’t charge interest.
For most federal and private loan borrowers, opting for a pause in payments at 0% interest isn’t an option. Lenders don’t make any money, and borrowers don’t have any incentive to make payments. Five years ago, the idea of an interest-deferement was a pipe dream for borrowers.
The Covid-19 pandemic changed things. In March of 2020, federal student loan borrowers were put on a payment pause that did not charge interest. More recently, borrowers on the SAVE repayment plan were put on an interest-free forbearance while the legal challenges to block the plan are being litigated.
When these payment pauses happpen, the analysis changes. For the borrowers who find themselves with an interest-free forebearance, making payments is almost always a mistake. Borrowers have several great alternatives to choose from. For example, instead of paying down an interest-free loan, these borrowers can put money in a savings account, earn interest, and then make a lump sum payment as the interest-free forbearance is coming to an end.
When should you get an interest-charging deferment?
The answer to this question is pretty easy.
If you absolutely cannot afford to pay your loans, and you have no other choice, pick a deferment.
While deferment is a bad idea for the reasons already discussed, delinquency and default are much worse. Not only will you run into late fees and still get hit with the huge interest payments, but it will also hurt your credit score.
The key takeaway: Only seek deferment when you’re truly unable to make your student loan payments, not simply to avoid them.
Even in this emergency situation, a deferment only makes sense some of the of the time.
Obtaining a deferment may be a logical move if you’re waiting for your first paycheck from a new job. If there is no extra income in your future, and your bills are not going to change, a deferment won’t fix anything. Six months later you will be in the exact same position, except your loan balance will be larger.
Borrowers who cannot afford their debt and don’t see things changing need to work with their lenders to investigate options to get lower interest rates or change repayment plans.
Deferment and Forbearance Alternatives
Part of the reason a deferment or a forbearance is usually a bad idea is because better alternatives exist.
For borrowers challenged by federal loans, income-driven repayment plans offer the ability to get lower payments, potentially down to $0 per month. Though the monthly bill is identical to a deferment, it helps a borrower work toward forgiveness.
Private loans get more tricky, but with many options to lower interest rates, borrowers should be pursuing these options before settling for a deferment or a forbearance.
