What they may wonder, especially as they approach graduation, is exactly how much they’re going to pay back. Figuring this out includes understanding the factors that may impact student loan repayment such as the interest rate, deferment, and forbearance.
Members of our Facebook group, Paying For College 101, also weighed in on how they are choosing to repay student loans so that interest doesn’t get out of hand.
Student Loan Interest Rates
When you’re comparing loans, you probably look at the interest rates. That’s wise, because they are one of the biggest factors in how much you’ll ultimately pay back.
How Interest Accrues & Compounded Interest
If you chose an unsubsidized federal loan or a private student loan, your student may have been able to wait to begin repayment until after graduation with an in-school deferment. However, interest is still accruing while they are in school.
With some loans interest compounds every day. This means that the interest from yesterday is added to the total sum, and that sum is used to determine the interest for today. Tomorrow, the interest from today will be included in the principal as interest is being calculated.
In the beginning, this daily compounding may not seem like a big deal. However it really adds up over time.
One parent noted, “If you can pay at least the interest—that is what really gets people is the interest compounding and rolling into the total—it can add up fast.”
With other loans, interest accrues during the in-school deferment period. However, interest capitalization will only occur once, upon entering your repayment period.
Capitalization is when unpaid interest is added to your loan principal. When you’re in school at least half-time or you’re in your grace period (the six months after you leave school full time) you may not have to make payments on your loan if you selected a fully deferred loan.
Before your first payment is due, any unpaid interest that has built up is added to the amount you borrowed. From that point on, interest accrues on the total balance.
This type of loan may help ease concerns of daily compounding compared with some other loan products.
Repayment Options During School
Because interest adds up so quickly and is immediately added to the principal of the loan, it’s a good idea to look for loans that have repayment options during school.
Some lenders allows you to choose between multiple different repayment options—including full repayment right away, interest-only payments in school, a fixed payment per month in school, or a full deferment until after graduation.
Using the interest-only repayment can keep your principal lower, which can lead to lower payments after graduation. Even paying $25 a month is better then a full deferment and can make a really big difference over the course of four years.
One parent in our group shared, “We are deferring, but our bank allows payments with no penalty. We plan on paying all along but without the penalty we feel better if we need to skip a payment.”
Another parent said they chose, “Interest only officially, but we will make additional payments whenever we can without penalty.”
Choosing a shorter repayment term and making payments before the loan enters repayment will always save you money and may be the best option depending on your unique circumstances.
Understanding Student Loan Deferments and Forbearance
Deferment is an option that allows your student to not repay the loan until after graduation. Deferment also refers to other times your student might pause their school loan while they pursue additional education or are on active duty in the military.
Forbearance refers to steps your student can take to pause student loan repayment during tough times. There will probably be a maximum number of months that you will be allowed to skip during the lifetime of the loan, and you’ll have to meet the lenders requirements for hardship.
Federal student loans have both deferment and forbearance easily available to the borrower. Private lenders often have delayed repayment and hardship programs as well, but they vary from lender to lender.
How Deferments and Forbearance Affect Repayment
It’s important to keep in mind that in almost every case, interest continues to accrue during deferment and forbearance. This means that when loan payments resume, they may be higher or it may be longer before your loan is paid off.
Pausing for a month doesn’t simply add one more month to the end of the loan term. It can add more than that because of the interest that accrues during the month you have “off.”
When Not to Use a “Pause”
There are times when a break from your student loan payments might be nice, but aren’t entirely necessary. These include the holidays, a month when you plan to take a vacation, or a time when you’re eyeing a major purchase.
While it’s tempting to skip a month or two in these cases, your student should avoid doing so. It’s easy to get in the habit of using these “skips” over and over.
Not only will this cause the interest to add up and additional payments to need to be made, it can affect the availability of deferment or forbearance in cases of true need. Many lenders have a specific total of months for deferment or forbearance that you cannot exceed in the life of your loan. Your student doesn’t want to use these up and then really need the break in the future.
Good Time to Request a Forbearance
On the other hand, there are times when it makes sense to request a pause in student loan payments, even if interest does continue to accrue.
These are times of true emergency and financial hardship. Maybe your student will buy a home but have a hard time selling the old one. Paying two mortgages is a hardship. So is facing an extended period of unemployment, or being disabled.
Optimal Way to Pay Off a Student Loan
The best way to pay off a student loan is the same way the tortoise won in the famous fable. “Slow and steady wins the race,” so, consistent payments over time will help your child pay the least interest possible and finish their student loans as quickly as they can.
If your student can pay something toward the loans in college, do it! Even if they choose deferment they can make payments that will be credited toward the debt. After graduation, try to avoid deferment and forbearance and simply keep paying on time.
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