Is It Worth Paying Interest During Student Loan Forbearance?
Postponing installments towards student loans through forbearance or deferment can be a tremendous relief. However, interest would still accrue on these loans in both circumstances. You can either pay this amount or let it capitalize. The latter option will increase the total debt.
Read on to learn if you should keep making interest-only payments during this period.
How Do Interests Accrue?
Accrued interest is the percentage of the principal that you’d owe on the loan, based on the timeframe of the last installment and annual rate. When a lender capitalizes on this amount, it’s added on to the total owed from the last payment. This amount is then added to the total cost of the loan.
Forbearance can help in delaying student loan payments for a certain duration. This especially helpful for the students who find it difficult to make timely payments. In any case, a percentage of the principal will be accrued on the loans. If you don’t pay these on time, they’ll be added to the total loan amount.
The loan types that don’t collect a percentage of the principal at the time of deferment include Perkins loans, subsidized parts of FFEL consolidation and direct loans, and subsidized student loans. In this situation, the total amount keeps expanding.
It’s recommended that you always pay the interest on the loan amount, if possible.
What Happens When You Allow Interest To Accrue?
A percentage of the principal will continue to accrue if it’s not paid. When this happens, the rate gets capitalized at the end of the forbearance period.
Suppose a student owes $40,000 with a 5.7% rate. This student is on a standard repayment plan of ten years. At some point, the student opts for one-year forbearance. No payments towards the percentage of the principal are made during that period.
In such circumstances, a total rate of $1,260 ($105 per month) would accumulate for the year. This would get added to the student loan balance of $40,000. At the end of the forbearance period, the balance amount of the loan would be around $41,260.
What Happens When You Keep Paying The Interest During Deferment Or Forbearance?
If payments are regularly made during forbearance, the interest won’t accrue on the balance loan amount. This helps you keep the outstanding principal from increasing.
For instance, you have a total debt of $40,000 with a 5.7% APR. You took a forbearance for 12 months. In this case, your monthly payments will be around $438. Out of this amount, $105 will be the monthly rate and the rest will go towards the principal. When you keep paying $105 every month, your outstanding debt will be lowered, thus saving you from paying additional interest. By the end of the year, you’ll be able to lower your principal by $1,260.
What Are Your Alternatives?
If you disqualify for deferment or forbearance, then there are two alternatives you can consider.
- Income-driven repayments: In this option, the borrower would still have to make the monthly payment but could base it on their income. This could significantly reduce the payment amount that’s due each month
- Student loan refinancing: For borrowers with a good credit score, refinancing their student loan would be an ideal way to qualify for a reduced rate. However, if the borrower opts to refinance the federal student loans, he wouldn’t be liable to qualify for an income-driven repayment or forgiveness program. The new lender would pay off all the old lenders with a reduced rate, which would also help in saving some money
If you opt for a forbearance on your loan, make sure to clarify what percentage of the principal will be accrued during the period. Speak to the lender and understand if unpaid interest will capitalize and increase your overall debt. The best way to keep your loan account manageable is by making at least interest-only payments during forbearance.