One of the great things about federal student loans is that if you are in economic distress, you have some options to avoid default. Unlike private student loans, which often provide borrowers with very few (if any) meaningful ways of dealing with something like the loss of employment or a serious medical issue, the federal government offers generous amounts of forbearance, allowing borrowers to postpone their payments.
For someone in serious distress, federal loan forbearance on the basis of general economic hardship can be tremendously helpful. You don’t pay a fee, you generally don’t need an application, and you don’t need supporting documentation. You can simply call your servicer and request the forbearance over the phone, or you can do so via your online account. It’s as easy as 1-2-3: make a call (or click your mouse), put in the request, and boom! You can postpone your payments for one month, six months, a year, or longer (although you may have to renew the request periodically).
Except there’s a catch, and that catch is interest. Few borrowers are ever told about the interest consequences of going into long-term forbearance, and too often I’ve seen borrowers use forbearance as a way to push off paying their federal loans for as long as possible. The vast majority of the time, these borrowers are not bad or irresponsible people; they may have legitimate economic and/or health-related problems and simply do not have the resources to handle another bill. And since obtaining forbearance is so easy, it can also be easy to forget about your loan when you don’t have to make any payments on it.
But while the borrower is not paying much attention, interest is accruing, and the balance is increasing. Let’s take a look at what happens to a $50,000.00 federal student loan with a 6.8% interest rate in forbearance:
After 6 months, the balance grows to approximately $51,700.00.
After 12 months, the balance grows to approximately $53,400.00.
After 24 months, the balance grows to approximately $57,000.00.
After 36 months, the balance grows to approximately $61,000.00.
Most forbearances are time-limited and cannot be extended after 36 months. So in the above example, the borrower bought himself three years of postponed payments at a price of $11,000.00, which is 22% of his original loan balance. He now has to pay this all back. Furthermore, the interest that accumulated during the forbearance period will now be capitalized (added to the original principal), and interest will continue to accrue at 6.8% on that higher total balance. This will cause the overall balance to continue to grow, and it necessitates larger monthly payments to pay it down.
Thus for most people, forbearance only makes sense as a short-time measure. If you lose your job and need a few months to get back on your feet, or you have an unexpected expense that causes you to be stretched too thin financially for a month or two, forbearance could be a viable option to avoid missing a payment. However, for long-term repayment management, it is generally preferable to get onto a payment plan that results in the payoff of your loan, or an income-sensitive repayment plan such as Income-Based Repayment that gives you an affordable payment schedule while putting you on track for eventual loan forgiveness. While you’re in forbearance, you’re not making any progress towards anything, and you might be shocked at how much it will cost you in the long run.
