There are a wide range of reasons a student might elect to take a gap year. Some want to earn a little extra money or focus on travel, while others use the time to prepare for graduate school.
While there are a multitude of reasons why a student might elect to take a gap year, the student loan consequences are pretty much identical for all.
In many cases, existing student debt won’t have a huge impact on gap year plans. However, putting together a strategy from the beginning can have huge benefits.
The Student Loan Grace Period and a Gap Year
All federal loans come with a grace period of at least six months. The “grace period” is the time after a student leaves school but before payments start. If a student stops attending school in May, by November, they can expect to start making payments.
With private loans, a grace period is just a term of the contract. Some lenders may specify a shorter grace period or no grace period at all. However, in most cases, private student loans have a six-month grace period, just like federal loans.
This means that in a 12-month gap year, a borrower may only have to make payments for the last six months.
The downside is that borrowers only get one grace period. This can complicate things for the borrowers who return to school and take out additional loans. Upon graduation, a borrower who took a gap year may have some loans that immediately have payments due, while other loans are just beginning their grace period.
It is also worth noting that loans on a grace period still generate interest in most cases.
Interest Will Continue to Accrue*
Borrowers have several tools at their disposal to delay or reduce payments that might be required during a gap year.
Federal loans have income-driven repayment plans, which means that a borrower may conceivably owe $0 per month, depending upon their income. Private lenders may allow borrowers to take an additional forbearance or deferment at the end of the loan grace period.
Unfortunately, the reduced or delayed payments come with a major downside: student loan interest. Every day, the student loans will generate more interest, growing the balance.
Taking a year off from school means student loan borrowers are giving their debt an extra year of growth. This is an extra cost to a gap year that borrowers should carefully consider.
However, there is one way of avoiding interest charges that will work for many federal borrowers…
Avoiding Interest Charges
Federal borrowers now have the opiton of the SAVE repayment plan.
Unlike the other federal income-driven repayment plans. SAVE offers a generous subsidy that covers 100% of the monthly unpaid interest. For the borrowers who qualify for $0 per month payments, SAVE will cover 100% of the interest charges. This means that your federal balance will not increase despite taking a year off and not making any payments.
It is also worth noting that as an IDR plan, SAVE payments are calculated based upon your most recent tax return. Thus, if you were a full time student last time you filled out your tax return, odds are very good that you can qualify for $0 per month payments. This is true even if you work during your gap year.
For the borrowers who don’t qualify for $0 per month payments on SAVE, the subsidy is still available. This calculator will break down your monthly SAVE payment and subsidy.
Borrowing Implications Upon Returning to School
For the most part, borrowing student loans after a gap year works just like it did before the gap year.
However, there are a couple of major exceptions that borrowers should understand.
First, those who take a year off of school to earn extra money may find that they qualify for less need-based aid when they return to school. This could mean fewer grants, and it could mean that borrowers only qualify for unsubsidized federal loans instead of subsidized loans. This could be an important factor for people considering taking a year off of school to improve their finances.
Second, financial decisions made during a gap year could impact future student loan borrowing. If someone runs up a bunch of credit card debt during their gap year travels, they may find it harder to qualify for private student loans upon returning to school. Additionally, missed student loan payments during a gap year can make qualifying for future loans far more difficult.
Avoiding financial mistakes during a gap year is one of the reasons why it is so important for borrowers to stay organized.
Tracking Student Debt During a Gap Year is Essential
Anyone who takes a year off of school will have to interact with their student loan companies. It could be to request an additional deferment or a lower payment, but these interactions are almost impossible to avoid.
Avoiding missed payments and protecting a credit score is important, but the benefits go beyond the obvious.
One harsh reality that many student loan borrowers discover is that they have no control over the company that owns their debt. Private lenders routinely sell the debt to other companies. Federal servicers often change. When this happens, it can be very difficult for borrowers to know who to pay or how much they owe. Some don’t learn that their debt has been sold until a creditor calls them asking about missed payments. By that point, the credit score damage may already be done.
Because a loan may be sold to another lender, it is critical borrowers update their contact info with their lenders.
Providing loan servicers with up-to-date contact information may seem like a favor to the lender, but it is much more. Providing contact info is necessary to protect the borrower. If the loan servicer or lender changes, it is crucial that borrowers do not miss this notice.
The Lesson: Plan Ahead
While there are many reasons why a borrower might choose to take a gap year, the one constant is that it is imperative they have a plan in place for their student loans.
Borrowers should know when repayment will start, what repayment plans they have available, and how they will be able to afford the monthly payments.
Skipping the planning stage could mean late fees and unnecessary accumulation of interest.