It may be better to pay at least a small amount towards student debt through income-based repayment programs than to choose forbearance and accrue capitalized interest. (SIphotography/Getty Images)
Postponing payment on student loans can be tempting for many new graduates who feel cash-crunched, but doing so can lead to ballooning payments down the road.
Borrowers can postpone their monthly loan payments with forbearance, but unpaid interest during forbearance still accrues and capitalizes. This means accrued interest is added to the principal, and the interest will be calculated based on the new, higher balance.
“I went the forbearance route, and it added thousands of dollars to my loan balance,” says Cornelius Davis Jr. of Atlanta, who earned both his bachelor’s and graduate degree from Jackson State University in Mississippi. “Not being in position to start repayment, l decided to put it in forbearance [after earning a graduate degree] and ended up leaving it there for close to seven years.”
During that time, Davis says his student loan balance nearly doubled from around $38,000 to $72,000.
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“Looking back I would not have left the loan in forbearance as long I did. The other mistake I made is not paying anything toward the interest over those seven years,” says Davis, who has since paid off his debt after refinancing with a private lender at a lower interest rate.
Although experts say this option should only be used on a short-term basis to ease financial hardship, some borrowers enter forbearance for prolonged periods resulting in excessive debt. In fact, borrowers are sometimes told that forbearance is a good choice for them – especially if they’re having difficulty making payments.
Borrowers may not always receive the best information from a student loan servicer about their repayment options, consumer protection advocates say. Servicers, such as Navient Solutions or Nelnet Inc., maintain loans on behalf of the U.S. Department of Education and perform tasks including collecting payments and responding to customer service inquiries.
“[Student loan] servicers sometimes push forbearances because they are easy. It takes just a few minutes to explain, and the form can be completed by telephone. Compare that with the forms for income-driven repayment, which are 10 pages long and can’t be completed by telephone,” says Mark Kantrowitz, a college financial aid expert and adviser to Savingforcollege.com.
While borrowers can’t enroll in an income-driven plan over the phone, student loan servicers can describe these options to callers, experts say.
Kantrowitz adds that explaining income-driven repayment plans over the phone can be more time-intensive than describing forbearance as an option. “They have a financial incentive to keep telephone conversations as short as possible,” he says.
A recent Government Accountability Office report also found that default management firms, which some schools hire to reduce their cohort default rates, encouraged recent grads to opt for forbearance. In some instances, consultants offered $25 gift cards to steer borrowers to select forbearance.
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Cohort default rates, known as CDR, on borrowers during their first three years of repayment are used by the U.S. Department of Education to determine a school’s eligibility in the federal financial aid program, which allows schools to award federal direct student loans and Pell Grants; loans that are more than 360 days past due are considered to be in default.
The CDR metric is intended to hold institutions accountable for student outcomes. According to the Office of Federal State Aid at the Education Department, an institution with a default rate of at least 30 percent or greater for its three most recent years could face sanctions that prevent it from participating in the federal financial aid program.
On the other end of the spectrum, institutions with low CDR rate are rewarded. If a higher education institution holds a CDR of less than 5 percent, it may disburse federal student loans to cover the cost of attendance for study abroad programs.
The GAO report states: “Some consultants have an incentive to encourage forbearance in particular as a strategy to prevent borrowers from defaulting within the 3-year CDR period in an effort to lower their client schools’ CDRs.”
Since the GAO report, members of Congress are calling for improvements to the formula.
“The GAO’s report reveals an astonishing lack of accountability and transparency in the default management industry that results in borrowers owing thousands of dollars in additional debt and facing a greater risk of default,” said California Democrat Rep. Mark Takano in a press statement. “The Department of Education must use the full extent of its authority to rein in abusive firms and protect student loan borrowers.”
Michael Lux, an Indiana attorney and founder of The Student Loan Sherpa, says the findings aren’t a surprise since schools and students often have different objectives. “The schools have a huge interest in sending students out in the world who are not in default, but not being in default is not the objective of students. Their objective is to pay off their student loans,” he says.
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Experts say the main reason recent grads should use forbearance is if they’re in a temporary cash crunch.
“If you don’t have a plan to address your student debt, postponing will only make things worse,” Lux says.
Here are a couple tips for borrowers on how to avoid a forbearance:
Consider an income-driven repayment plan. Income-driven repayment plans may be a better choice for borrowers who are having difficulty repaying their federal student loans for an extended period of time, experts say. Monthly payments under an IDR plan are determined by income and household size. In some cases, payments can be as low as $0; a few of these plans forgive the loan balance after 20 or 25 years of repayments.
Davis, who now works as a personal development coach, says: “I would tell a recent grad to avoid forbearance by opting for an income-based repayment plan. A smaller payment is better than no payment at all.”
Additionally, recent Education Department data indicates that borrowers who enroll in certain IDR plans, such as Revised Pay As You Earn, or REPAYE, have lower delinquency rates compared with those in the 10-year standard repayment plan.
Ask the student loan servicer or lender for a reduced monthly payment. Some lenders or servicers may be willing to lower monthly payments temporarily, depending on a borrower’s circumstances.
“If you need a forbearance, consider asking the lender for a reduced monthly payment instead of a complete cessation of monthly loan payments. This will keep the loan from getting large,” Kantrowitz says.
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