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Postponing federal student loan payments through deferment or forbearance can bring much-needed relief to your finances. But deferred loans do accrue interest, unless they’re subsidized. Plus, interest will still accrue on your loans during forbearance, regardless of whether they’re subsidized or unsubsidized.
Because your interest costs will add up (and may be added on to your principal balance when you resume repayment), it’s a good idea to pay student loan interest while in deferment or forbearance if you can help it. Alternatively, you could simply adjust payments by applying for an income-driven repayment plan instead.
Let’s look at these three questions:
Do deferred loans accrue interest? Usually yes
All federal student loans accrue interest in forbearance, and unsubsidized loans accrue interest during deferment. The only loans that don’t accrue interest during deferment are subsidized student loans, Perkins loans and the subsidized portion of Direct or FFEL consolidation loans.
Because your balance will likely keep growing, you have two choices for dealing with the interest that is charged each month.
Option 1: Paying student loan interest while in deferment or forbearance
One option is to pay only the interest as it accrues. As you’ll see below, this is the most cost-effective option and can prevent your total loan balance from ballooning when the deferment or forbearance period is over.
Unfortunately, this isn’t an option for everyone.
“This is a cash flow issue for most students and families,” noted Fred Amrein, founder of College Affordability LLC. “If a family or student borrowed the money, then they most likely do not have the funds to pay the interest.”
If you borrowed because you didn’t have extra money to pay for school, even if you wanted to pay the interest, you may simply not have funds available to do so. This would leave you no choice but to use the second option.
Option 2: Allow interest to accrue without paying it
The other option is to not pay the interest and instead allow it to continue accruing without paying it. If you do this, the interest is capitalized — rolled into your loan’s principal balance — in almost all circumstances (note that unpaid interest is not capitalized on Perkins Loans).
If you decide not to make payments toward the accruing interest, it will capitalize at the end of your forbearance period. Our student loan deferment calculator can help you determine the amount of interest that will accrue and capitalize during forbearance.
Let’s look at an example of how making interest payments versus allowing interest to capitalize affects the total cost of your debt:
Say you owe $35,000 in student loans at a 5.70% interest rate and you’re on the 10-year Standard Repayment Plan. You enter forbearance for one year and pay no interest during that time.
In this case, a total of $1,995 in interest would accrue over the year. This would be added to the $35,000 you originally owed. You’d end the forbearance period with a new loan balance of a little over $36,995 (because interest accrues daily), and going forward, you would pay interest on this higher loan balance. Essentially, you’d pay interest on the interest that built up while you were in school.
Now let’s look at this example again, except let’s assume you make interest payments during forbearance. By paying the $1,995 in interest that accrued during the year of forbearance, you’d prevent it from capitalizing. When your forbearance period ended, you’d still owe $35,000, and the payments and interest you’d make over the next decade would be based on a lower initial loan amount.
Should you pay interest on student loans in forbearance?
Because student loan forbearance does not stop interest from accruing on loans, it often makes sense to pay the interest while your loans are in forbearance, if it’s financially feasible.
“With interest rates being so low, students are not earning much interest on their savings,” said Peter Bielagus, financial author and speaker. “A great way to ‘save’ money is to stop losing it. Making even just a $10 payment here and there on a student loan with a 5% interest rate should be viewed as ‘earning’ 5% on that $10.”
But despite the substantial savings and the fact that paying interest would prevent you from increasing your student loan debt burden in forbearance, there are a couple situations where paying interest during forbearance doesn’t make sense.
One example is when you’re trying to pay other higher interest debt: “If a student owes $10,000 at 5% on a student loan and $3,000 at 18% on a credit card, it makes more sense to attack the credit card first,” Bielagus said.
Another situation where it doesn’t make sense to pay interest while you’re in forbearance is when you’re not planning on paying back your loans in full. According to Amrein, “if the borrower will qualify for Public Service Loan Forgiveness, it makes no sense to make that interest payment.”
It wouldn’t make sense to repay the interest then because it doesn’t matter if your loan balance is higher at the end of forbearance. The interest that’s tacked on just means more debt will be forgiven after you meet the requirements for loan forgiveness.
If you plan to repay your loans based on an income-driven repayment plan, you may assume it doesn’t make sense to pay interest in forbearance, since your monthly payment is capped based on your income — so it might not be higher because of the capitalized interest. However, if your total loan balance is higher and you pay off less of it, a larger amount will be forgiven — and you’ll be hit with a bigger tax bill, since you’re taxed on the forgiven amount.
If you’re in student loan forbearance, what should you do?
For the millions of students in forbearance, there is no one right answer on whether to pay interest or not. Ultimately, every borrower’s situation is different.
For many in forbearance, if you can afford to make payments and you’re not going to use Public Service Loan Forgiveness, it makes sense to save yourself money by paying the interest.
It might also be a better option to put your loans on income-driven repayment. Depending on your income, your loans could be as low as $0 per month, but you’ll still be making progress toward the end of your repayment term.
Whether you’ve paid interest during deferment or forbearance or you haven’t, you could potentially save on your loan by refinancing and reducing your interest rate once you begin repaying your loans.
Still, refinancing may not make sense for everyone, as private loans typically don’t offer forbearance or deferment; you could be in financial trouble if you can’t pay your loan again in the future.
However, if you’re confident you can make your loan payments going forward and want to explore your options, there are a number of choices to refinance your student loans and potentially reduce the total interest you must pay over the life of the loan.
Rebecca Safier contributed to this report.
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