If you’re struggling to make ends meet, asking your student loan provider for a payment break may seem like a good idea at first glance – but think again.
Forbearance can add thousands of dollars in interest to a student loan. That’s why banks and lenders don’t mind forbearance, and may even steer struggling student loan borrowers into taking a repayment break. That’s a scenario that borrowers may well want to avoid.
The Problems with Forbearances
Lenders offer forbearance to borrowers who need a break from repaying their student loans.
Forbearance allows a struggling borrower to stop making payments on their student loans for a specific period of time and to resume those payments when they’re back on firmer financial ground.
Under forbearance, interest continues to accrue on the loan, just as it accrues during any other period, whether the borrower is actively repaying the loan, or not.
But, suspending repayment can increase the borrower’s costs and make it more difficult to repay the debt. The problems with forbearance are caused by the failure to pay the interest as it accrues. Forbearance is a form of negative amortization, where the loan payments are less than the new interest that accrues.
- No payments, whatsoever. Forbearance is a period of time when the student loan borrower isn’t making any payments, not even payments toward the interest. Other types of non-payment, such as delinquency and default, also have interest accruing on the student loan.
- Capitalization of interest compounds the problem. At the end of the forbearance period, the accrued but unpaid interest is added to the loan balance, increasing the amount of debt.
- Charging interest on interest. When the interest is capitalized, interest starts being charged on the interest, increasing the cost of the loan.
- Little or no progress in repaying the loan. Student loan payments are applied first to interest, and, if there’s any money left over, the remainder reduces the principal balance of the loan. Consequently, when you pay less, it doesn’t pay down the principal balance as much, if at all.
A 2017 study by the Government Accountability Office states a typical student loan borrower with a $30,000 student loan who puts his loan into forbearance for three years — the maximum allowed for forbearance — pays an extra $6,742 in interest on the student loan.
Alternatives to Forbearances
If, after all, you decide you absolutely have to delay your student loan payments, and there’s no way you can cut your budget, or add more income in the form of a second job, consider these alternatives:
- Deferment. If you have subsidized Federal Stafford loans or Federal Perkins loans, consider deferment instead. Deferments are similar to forbearances, but the federal government pays the interest on the subsidized loans. Interest still accrues and is capitalized on unsubsidized loans.
- Partial forbearance. During a partial forbearance, the borrower makes reduced, interest-only payments. By paying the interest as it accrues, the borrower prevents the loan from growing larger. The federal government doesn’t offer partial forbearances, but borrowers can implement a partial forbearance by voluntarily making payments of interest during forbearances.
- Income-driven repayment plans. Income-driven repayment plans, such as income-based repayment and pay-as-you-earn repayment, base the monthly payments on a percentage of the borrower’s discretionary income Discretionary income is the amount by which adjusted gross income exceeds 150 percent of the poverty line. Monthly loan payments are usually much lower than under other repayment plans, and may even be negatively amortized. During the first three years, accrued but unpaid interest is paid by Uncle Sam.
These options buy you some time to regroup financially, and resume your regular student loan payments.
On Forbearance, Think It Through
If you’re a student loan borrower who’s lost a job or suffered a big financial hit, the thought of temporarily avoiding your student loan payments is tempting.
The reality is, though, that you’re likely making your financial situation worse by agreeing to forbearance, when there are better alternatives.
Before you choose a forbearance, be sure you’re taking the best steps to address your problem, without making loan servicers wealthier, and yourself poorer.