What Does a Deferred Loan Mean and How Does It Work?

Financial challenges can make it difficult to meet loan payment obligations. When faced with unexpected circumstances like job loss, illness, or economic hardship, individuals often seek temporary relief. Loan deferment provides borrowers with a temporary pause in their loan payments. This allows them to manage finances during difficult periods.

Understanding Loan Deferment

Loan deferment is a temporary suspension of loan payments. Borrowers are not required to make principal and sometimes interest payments for a specified period. This arrangement is a formal agreement between the borrower and the lender, granted based on specific eligibility criteria. During a deferment, the loan term typically extends by the length of the deferment period.

Interest accrual is a key aspect of deferment. For some federal student loans, like subsidized direct loans, the government pays the interest during the deferment period. This prevents the loan balance from increasing while payments are paused. However, for unsubsidized federal student loans, Direct PLUS Loans, and most private loans, interest continues to accrue. If this accrued interest is not paid, it can be added to the principal balance at the end of the deferment, a process known as capitalization, which increases the total amount owed.

Common Scenarios for Loan Deferment

Loan deferment is frequently available for specific loan types and circumstances. Student loans often offer deferment options, such as while a borrower is enrolled in school at least half-time, during periods of unemployment, or due to economic hardship. Military service, cancer treatment, and participation in graduate fellowship programs can also qualify federal student loan borrowers for deferment.

Mortgage loans may also offer deferment, particularly in situations of temporary financial hardship like job loss, illness, or natural disasters. Deferred payments might be added to the end of the loan term, or a lump-sum payment may be required later. Some lenders for auto or personal loans might offer deferment options, typically requiring proof of financial distress. The availability and terms for these deferments vary significantly by lender and the specific loan agreement.

Deferment Versus Forbearance

Both deferment and forbearance allow for a temporary halt in loan payments, but they differ significantly regarding interest accrual. Deferment can prevent interest from accruing on certain federal subsidized student loans, where the government covers the interest during the pause. This means the loan balance does not increase during the deferment period for these specific loan types.

Forbearance involves interest continuing to accrue on all loan types, including federal subsidized student loans. This accrued interest, if not paid, will be added to the principal balance, increasing the total cost of the loan. Forbearance is granted for broader reasons of financial difficulty and may have more flexible eligibility criteria than deferment.

Financial Implications of Deferment

The financial consequences of loan deferment depend heavily on whether interest accrues during the deferment period. For loans where interest continues to accrue, such as unsubsidized student loans or most private loans, the total cost of the loan will increase. This is because unpaid accrued interest is added to the principal, leading to a larger loan balance on which future interest is calculated.

Deferment also extends the overall loan term, as the period of suspended payments is typically added to the end of the original repayment schedule. Regarding credit scores, a properly granted and managed deferment generally does not negatively impact a borrower’s credit. Lenders report the loan’s status as deferred, which is distinct from a missed payment. However, if a borrower misses payments before approval or fails to follow deferment terms, negative impacts on credit can occur.

The Deferment Process

Initiating a loan deferment typically requires the borrower to contact their loan servicer directly. This step helps understand the specific eligibility requirements for deferment options. Borrowers usually need to provide documentation verifying eligibility, such as proof of unemployment, enrollment status, or military service.

After gathering supporting documents, the borrower must complete a specific deferment request form provided by their loan servicer. Continue making payments as scheduled until official notification of approval is received, as processing times can vary. The loan servicer will then review the application and documentation to determine if deferment can be granted.