Deferment Period
An agreed period during which the borrower is not liable to pay interest or repay the principal on the loan taken.
What Is A Deferment Period?
The deferment period is an agreed period during which the borrower is not liable to pay interest or repay the principal on the loan taken. This is also the period following the issuance of a callable security, during which the issuer cannot call the guard.
The interest accrued during this period is added to the amount payable by the borrower at the end of this period.
The duration of the period can vary and is usually decided by a contractual agreement between the lender and the borrower. For example, the deferment period on a student loan is generally up to 3 years, while on a municipal bond, it is 15 years.
It provides excellent relief to the borrowers to get funds without the stress of repaying the principal and interest for a certain period. On the other hand, a deferment period is advantageous because it gives the borrower breathing room but also increases the borrower's debt due to missed payments.
Key Takeaways
- A deferment period is a pre-approved agreement that allows a borrower to temporarily postpone making loan payments, typically including both principal and interest.
- It's important to understand that deferment is not debt forgiveness. During the deferment period, the borrower is still responsible for the entire loan amount plus any accrued interest.
- Deferment is not always available and may have specific requirements depending on the loan type and lender. The duration of the deferment period also varies based on the loan program.
- Deferment periods are often offered for student loans during enrollment or for borrowers facing financial hardship.
Types Of Deferment Period
Borrowers can be granted various loans in the financial sector. The periods of deferment can vary depending on the type of loan. Here is a list of different types of loans with varying periods of deferment.
Student Loans
Student loans are granted to borrowers to fund their studies. It is provided to students either in school or who have just completed their graduation with fewer resources to help them support their higher education expenses.
The deferment period on student loans is usually 2-3 years, and the accrual of interest varies. Primarily, interest does not accrue on subsidized deferred student loans and accrues on unsubsidized.
Mortgages
A mortgage is a loan used to purchase a house or any real estate property. The home or property purchased works as collateral, and the borrower agrees to pay the amount in the form of principal and interest over time.
The period on mortgages is usually one month. The borrower is not liable to pay interest and principal in the first month of the newly established mortgage loan.
Let's say Alan borrows a mortgage loan in December. He might not need to make payment in January. So he can start paying off his loan from February onwards.
Insurance
The deferred period of insurance is when an individual becomes incapacitated, and the benefit starts to be paid.
It is the amount of time an employee must be out of work owing to illness or injury before benefits begin to accrue and claims are paid.
Options
There are two types of options: European Options and American Options. European options have a period of deferment that lasts the entire life of the opportunity. They can only be used on the expiry date.
At the same time, the American options can be exercised anytime before expiration. However, payment is postponed until the option's original expiration date.
American options are costlier and more valuable than European options since it gives the option holder the right to exercise the option anytime after entering into the contract and before the expiration date. Also, it includes an added cost of the premium.
Callable Securities
Different types of securities may contain an embedded call option that allows the issuer to repurchase them at a predetermined price before the maturity date. These types of deposits are known as callable securities.
When interest rates in the economy fall, an issuer will buy back bonds, allowing the issuer to refinance its debt at a lower interest rate.
The deferment period of callable securities is when an issuing entity cannot redeem bonds. The underwriter and the issuer predetermine it at bond issuance. During that period, the issuer cannot call the security back.
Taxes
Taxes are the mandatory contributions levied by the government on individuals, businesses, or companies. The government can also impose various taxes, such as income, sales, etc.
While many businesses pay employees' salaries and taxes throughout the year, some also include Employee Share Schemes (ESS). If the employees receive ESS, the company may defer their tax until the next fiscal year.
This means that the government can tax them for the market value of the interests at the deferred taxing point at the end of the fiscal year. In addition, clients can defer their tax payments by submitting documents demonstrating exceptional and unforeseeable occurrences.
Deferment Period Vs. Grace Period
The deferment period and grace period are the periods during which the borrower is not liable to make a payment towards interest or principal on the loan to the lender.
Depending on the loan terms, interest may or may not accrue during the grace period, while during the period of deferment, the interest gets accumulated, which can be very impactful on the interest owed.
The grace period tends to be built into the initial loan terms when applying. In contrast, the deferment period requires an application and other documents showing that the borrower is going through financial hardships and cannot make the payment.
In the long term, deferring loan payments can have a more significant financial impact than paying loans during a grace period.
Late payments during the grace period don't cause the borrower to default on the loan, while there is a risk of bankruptcy in case of deferments. Unlike grace periods, postponements have a more significant impact on your financial health.
For example - if your billing cycle ends on the first of each month and your bill is due on the 22nd of the month, your grace period is 21 days, while student loans have a period of deferment of 2-3 years when the student doesn't need to pay the installments.
Deferment Period Vs. Forbearance
Deferment Period and Forbearance are similar in that both postpone the loan payment if the borrower faces an economic crisis. However, these terms are different based on the accrual of interest and shouldn't be considered similar.
The length of the period varies by the type of loan ranging from 2-3 years to as long as a person qualifies, while forbearance does not last for more than 12 months.
Interest does not accrue during deferment on subsidized loans, while interest accrues on all the loans during forbearance.
The period is related to a particular event, such as a financial hardship due to illness, while no such event is required in forbearance.
Suppose you qualify for a student loan deferment. In that case, it's usually a better option than student loan forbearance because you can freeze your interest and loan payments for a longer duration in deferment than forbearance. In addition, interest will not accrue if you get subsidized loans.
Forbearance typically lasts up to 12 months, whereas deferment lengths vary depending on the loan the borrower applies for. However, it usually ranges from three months to three years.
Advantages & Disadvantages Of Deferment Period
Borrowers must be educated on the positives and negatives of the periods of deferment. Below is the list of advantages and disadvantages that periods of deferment offer.
The advantages are:
- It delays repayment of the interest and principal on the loan.
- The borrower is allotted time to overcome financial adversities during deferment.
- It relieves the stress of repaying the loan for a given period.
- The periods of deferment are comparatively longer than grace periods.
- In some cases, it can save money on late fees.
- It also avoids repossession of collateral in some cases.
The disadvantages are:
- The major disadvantage is that the interest gets accrued on the loan during the period.
- The overall outstanding loan balance is increased due to accrued interest.
- Sometimes, borrowers are subject to additional fees due to late payments.
- The borrower must submit supporting documents that they are experiencing financial hardship.
- The lender takes the risk of default by granting a period of deferment because the borrower may not be financially stable enough to pay the loan after the suspension period is over.
A deferment period is a viable option for those experiencing financial or economic hardship. Deferring loan principal and interest payments gives the borrower breathing room and allows them to get back on their feet.
However, the deferral raises the overall outstanding loan balance due to non-payment for a while. A borrower can avail of a variety of loans. Interest doesn't accrue on standardized loans.
The deferment period differs from the grace period and forbearance. Therefore, it can be a better option for the borrower who is going through an economic crisis to get through.
Deferment Period FAQs
Federal student loan forbearance typically lasts a year and has no maximum duration. Therefore, a borrower can request forbearance as often as possible, though the service providers limit the amount.
Because it occurs with the lender's approval, a student loan deferral has no direct impact on your credit score. However, student loan deferrals can lengthen and increase the amount of unpaid debt, which can harm a credit score.
Regardless of their names, deferment and forbearance have the same effect on private student loans: Interest always accrues, and only the borrower is responsible for paying it.
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