Student Loan Deferment - What’s the Deal With It?

Since the onset of the pandemic, few financial topics have received as much attention as federal student loans.

In the last two years, federal student loans have been placed in deferment, meaning that payments are not required to be made.  Interest has also not accrued during this time frame.  With this interesting development, we’ve received several questions regarding student loans, with the general consensus being, “What in the world am I supposed to do about these loans?”  Unfortunately, there’s not a right answer for every household – student loans are unique to each individual, so the correct action is dependent on the overall financial situation of the household.

Student loan goals can be broken down into two main categories:

  1. Eliminate them as quickly as possible.
  2. Utilize the Public Student Loan Forgiveness (PSLF) program to have a portion (or maybe all) of your federal student loans forgiven.

If your goal is to eliminate the debt as quickly as possible, refer back to our blog post regarding “4 Steps to Eliminate Debt.”  The same principles apply in this situation.  For individuals who are trying to eliminate student loans as quickly as possible, this period of deferment is a terrific opportunity to make significant progress.  Since the loans aren’t accruing interest, every payment is applied fully to principal.  Not only does this expedite your payoff, it also provides potentially significant interest savings over time.  

For example, let’s assume that a borrower has an outstanding student loan balance of $25,000, with an interest rate of 6%.  Depending on the remaining term of the loan, it’s possible that roughly 35-40% of the monthly payment could be applied directly to interest.  During this period, that additional 35-40% is applied to principal.  The other factor to consider is the guaranteed rate of return.  Anytime you pay additional amounts to principal, you have a guaranteed rate of return (because you are guaranteeing that you don’t have to pay interest on those principal amounts).  

If your goal is to utilize the PSLF program, it would be wise to pay as little as possible during this deferment.  In order to qualify for PSLF, 120 qualifying payments must be made.  

A qualifying payment consists of the following criteria:

  1. The borrower is employed at a “qualifying employer.”
  2. The borrower is utilizing the correct type of repayment plan.
  3. The borrower has the correct type of federal student loan.
  4. The borrower is satisfying the minimum monthly obligation set forth by the repayment plan.

During this deferment period, the minimum monthly obligation is $0.  Technically, a $0 payment satisfies this requirement.  Wild!  When utilizing the PSLF strategy, it’s critical to make sure that you’re following the guidelines, because the burden of proof resides on the borrower to prove that the payments have been correctly applied.  We’ll have a follow-up post on the PSLF program and all that it entails.

When deciding on the strategy that makes sense for you and your household, make sure to consult with your financial planner.  Student loans can’t be viewed in an individual silo – they must be viewed as a part of a cohesive strategy.

Clark Hayden, CFP®*

Financial Advisor, Partner, CFP®