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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:
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.
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.
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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1 Important Disclosures for Earnest.
To qualify, you must be a U.S. citizen or possess a 10-year (non-conditional) Permanent Resident Card, reside in a state Earnest lends in, and satisfy our minimum eligibility criteria. You may find more information on loan eligibility here: https://www.earnest.com/eligibility. Not all applicants will be approved for a loan, and not all applicants will qualify for the lowest rate. Approval and interest rate depend on the review of a complete application.
Earnest fixed rate loan rates range from 2.98% APR (with Auto Pay) to 5.79% APR (with Auto Pay). Variable rate loan rates range from 1.99% APR (with Auto Pay) to 5.64% APR (with Auto Pay). For variable rate loans, although the interest rate will vary after you are approved, the interest rate will never exceed 8.95% for loan terms 10 years or less. For loan terms of 10 years to 15 years, the interest rate will never exceed 9.95%. For loan terms over 15 years, the interest rate will never exceed 11.95% (the maximum rates for these loans). Earnest variable interest rate loans are based on a publicly available index, the one month London Interbank Offered Rate (LIBOR). Your rate will be calculated each month by adding a margin between 1.82% and 5.50% to the one month LIBOR. The rate will not increase more than once per month. Earnest rate ranges are current as of July 31, 2020, and are subject to change based on market conditions and borrower eligibility.
Auto Pay discount: If you make monthly principal and interest payments by an automatic, monthly deduction from a savings or checking account, your rate will be reduced by one quarter of one percent (0.25%) for so long as you continue to make automatic, electronic monthly payments. This benefit is suspended during periods of deferment and forbearance.
The information provided on this page is updated as of 7/31/2020. Earnest reserves the right to change, pause, or terminate product offerings at any time without notice. Earnest loans are originated by Earnest Operations LLC. California Finance Lender License 6054788. NMLS # 1204917. Earnest Operations LLC is located at 302 2nd Street, Suite 401N, San Francisco, CA 94107. Terms and Conditions apply. Visit https://www.earnest.com/terms-of-service, email us at [email protected], or call 888-601-2801 for more information on our student loan refinance product.
© 2020 Earnest LLC. All rights reserved. Earnest LLC and its subsidiaries, including Earnest Operations LLC, are not sponsored by or agencies of the United States of America.
2 Important Disclosures for Laurel Road.
Laurel Road Disclosures
All credit products are subject to credit approval.
Laurel Road began originating student loans in 2013 and has since helped thousands of professionals with undergraduate and postgraduate degrees consolidate and refinance more than $4 billion in federal and private school loans. Laurel Road also offers a suite of online graduate school loan products and personal loans that help simplify lending through customized technology and personalized service. In April 2019, Laurel Road was acquired by KeyBank, one of the nation’s largest bank-based financial services companies. Laurel Road is a brand of KeyBank National Association offering online lending products in all 50 U.S. states, Washington, D.C., and Puerto Rico. All loans are provided by KeyBank National Association, a nationally chartered bank. Member FDIC. For more information, visit www.laurelroad.com.
As used throughout these Terms & Conditions, the term “Lender” refers to KeyBank National Association and its affiliates, agents, guaranty insurers, investors, assigns, and successors in interest.
Assumptions: Repayment examples above assume a loan amount of $10,000 with repayment beginning immediately following disbursement. Repayment examples do not include the 0.25% AutoPay Discount.
Annual Percentage Rate (“APR”): This term represents the actual cost of financing to the borrower over the life of the loan expressed as a yearly rate.
Interest Rate: A simple annual rate that is applied to an unpaid balance.
Variable Rates: The current index for variable rate loans is derived from the one-month London Interbank Offered Rate (“LIBOR”) and changes in the LIBOR index may cause your monthly payment to increase. Borrowers who take out a term of 5, 7, or 10 years will have a maximum interest rate of 9%, those who take out a 15 or 20-year variable loan will have a maximum interest rate of 10%.
KEYBANK NATIONAL ASSOCIATION RESERVES THE RIGHT TO MODIFY OR DISCONTINUE PRODUCTS AND BENEFITS AT ANY TIME WITHOUT NOTICE.
This information is current as of September 9, 2020. Information and rates are subject to change without notice.
3 Important Disclosures for SoFi.
4 Important Disclosures for Splash Financial.
Splash Financial Disclosures
Terms and Conditions apply. Splash reserves the right to modify or discontinue products and benefits at any time without notice. Rates and terms are also subject to change at any time without notice. Offers are subject to credit approval. To qualify, a borrower must be a U.S. citizen or permanent resident in an eligible state and meet applicable underwriting requirements. Not all borrowers receive the lowest rate. Lowest rates are reserved for the highest qualified borrowers. If approved, your actual rate will be within a range of rates and will depend on a variety of factors, including term of loan, a responsible financial history, income and other factors. Refinancing or consolidating private and federal student loans may not be the right decision for everyone. Federal loans carry special benefits not available for loans made through Splash Financial, for example, public service loan forgiveness and economic hardship programs, fee waivers and rebates on the principal, which may not be accessible to you after you refinance. The rates displayed may include a 0.25% autopay discount.
The information you provide to us is an inquiry to determine whether we or our lenders can make a loan offer that meets your needs. If we or any of our lending partners has an available loan offer for you, you will be invited to submit a loan application to the lender for its review. We do not guarantee that you will receive any loan offers or that your loan application will be approved. Offers are subject to credit approval and are available only to U.S. citizens or permanent residents who meet applicable underwriting requirements. Not all borrowers will receive the lowest rates, which are available to the most qualified borrowers. Participating lenders, rates and terms are subject to change at any time without notice.
To check the rates and terms you qualify for, Splash Financial conducts a soft credit pull that will not affect your credit score. However, if you choose a product and continue your application, the lender will request your full credit report from one or more consumer reporting agencies, which is considered a hard credit pull and may affect your credit.
Splash Financial and our lending partners reserve the right to modify or discontinue products and benefits at any time without notice. To qualify, a borrower must be a U.S. citizen and meet our lending partner’s underwriting requirements. Lowest rates are reserved for the highest qualified borrowers. This information is current as of September 10, 2020.
5 Important Disclosures for CommonBond.
Offered terms are subject to change and state law restriction. Loans are offered by CommonBond Lending, LLC (NMLS # 1175900), NMLS Consumer Access. If you are approved for a loan, the interest rate offered will depend on your credit profile, your application, the loan term selected and will be within the ranges of rates shown. All Annual Percentage Rates (APRs) displayed assume borrowers enroll in auto pay and account for the 0.25% reduction in interest rate. All variable rates are based on a 1-month LIBOR assumption of 0.16% effective Sep 1, 2020 and may increase after consummation.