Student Loan Solution. David Carlson
or when you are on active-duty military service in connection with a war, military operation, or national emergency.
Interest While in Deferment
Deferment is one reason subsidized federal student loans are the best type of student loans. While you are in deferment, interest typically will not accrue for this type of loan. Unsubsidized loans, on the other hand, will accrue interest and capitalize once you exit deferment or a grace period following deferment, such as when you graduate or are no longer enrolled at least half-time.
Capitalization is the process of accrued interest being added to the principal balance of your loans.
As most grad students learn, the interest on unsubsidized loans can add up. If you are in grad school for three years or longer, there may be a sizable amount of interest that will be capitalized once you finish. The total accrued can be a bit shocking, particularly if you have a lot of unsubsidized loans and haven’t been regularly reviewing your loans (which I would bet is the majority of students).
While deferring student loans during undergrad and grad school usually makes sense, ideally you would continue to make payments that cover the interest on your unsubsidized loans. This will prevent interest from accruing during deferment, which ultimately increases the amount owed. With that said, I know making these payments while in grad school is not realistic for many.
For more information on deferment, to access the forms necessary to request the various types of deferment, or to see additional deferment opportunities, you can visit studentaid.ed.gov.12 You can also reach out to your loan servicer for more information on how to defer your loans.
Forbearance
Forbearance is a period of time during which your payments are temporarily suspended or reduced for up to twelve months, at which point you need to reapply. It’s a less desirable option than deferment because interest continues to accrue on all loans, regardless of what type of loan they are. Once your loans exit forbearance, the accrued interest is added to the principal balance of your loans through capitalization.
With that in mind, deferment is always better than forbearance. And, to be blunt, forbearance should be avoided at all costs.
To illustrate this example, let’s say you have forty-five thousand dollars in federal student loans at a weighted average interest rate of 6.5 percent. Below you can see the impact interest will have on your loans, based on how many months you remain in forbearance:
Even if just a portion of your loans were subsidized, you would be better off in deferment. On the flip side, if these were all unsubsidized loans, it wouldn’t make a difference whether they were in deferment or forbearance; both would accrue interest that eventually would be added to your principal balance.
There are two types of forbearance: general and mandatory.
General forbearance is at the discretion of your borrower. General forbearances are granted for any reason that is acceptable to the loan servicer. Typical reasons include financial difficulties, unemployment, change in employment, and medical expenses.
There is no supporting documentation required for general forbearance, and you can have it granted through a simple phone call attesting to your reason(s) for needing to put your loans in forbearance. There is no formal limit on how much time you can spend in forbearance, as long as it does not exceed thirty-six months at a time.
Mandatory forbearance must be granted if you meet eligibility requirements. Supporting documentation is required. Circumstances that make you eligible for mandatory forbearance include:
•You are serving in a medical or dental internship or residency program.
•The total amount owed each month for all your student loans is 20 percent or more of your total monthly gross income.13
•You are serving in AmeriCorps (in a position where you received a national service award).
•You would qualify for Teacher Loan Forgiveness based on the teaching service you are providing.
•You would qualify for partial repayment of your loans under the US Department of Defense Student Loan Repayment Program.
•You are a member of the National Guard, have been activated, and are not eligible for a military deferment.
If you have received mandatory forbearance based on your financial situation (i.e. owing 20 percent or more of your total gross income), your ability to continue in it is typically capped at three years.
With all this in mind, should you apply for forbearance? It’s almost never an ideal option but, if you are behind on your student loans, applying for forbearance makes your loans current, meaning you will no longer be behind on your payments. This option should be taken only if you are ineligible for deferment and unable to make the payments necessary to cover your missed payments. Additionally, if you are facing economic hardship or unemployment, you should always look to deferment first. With that said, it’s better to temporarily enter forbearance than to fall behind on your payments and risk defaulting.
Forbearance should be viewed as a short-term option and only be used when absolutely necessary. To find out more about forbearance and how to apply, visit studentaid.ed.gov.14
Student Loan Default
Student loan default is a real problem today. According to a January 2018 report by the Brookings Institution, nearly 40 percent of student loan borrowers may default on their student loans by 2023.15
For most federal student loans, you will default if you don’t make a payment in more than 270 days. What follows isn’t pretty. You lose eligibility to receive Federal Student Aid and, even worse, you can face consequences like wage garnishment or tax refund withholding.
The general steps in default are:16
1.You haven’t made a payment for more than 270 days.17
2.The entire balance, both principal and interest, becomes immediately due.
3.You lose access to options like deferment, forbearance, and repayment plans.
4.You either make repayment arrangements with the holder of your loan, or your loan gets placed with a collection agency.
5.The collection agency will offer the option of a voluntary repayment agreement.
6.If you don’t enter into the voluntary repayment agreement, or fail to make the agreed payments, the collection agency will take actions such as wage garnishment. If you are self-employed and they cannot garnish your wages through an employer, the US Department of Justice may take legal action—by suing you—to collect on the defaulted loans.
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