The Truth About Loan Deferment and Forbearance

Life is unpredictable. A sudden job loss, a major medical emergency, or a global pandemic can instantly turn your stable financial life upside down. When you can’t make your monthly payments, the fear of default and foreclosure is overwhelming.

In these moments, lenders offer two “lifelines” that sound like a miracle: Deferment and Forbearance.

Both are advertised as a “pause button” on your loan payments. They offer immediate relief, allowing you to stop paying your mortgage, student loan, or auto loan for a set period, giving you time to get back on your feet.

But here is the billion-dollar truth that lenders don’t put in their marketing materials: It is not a pause button. It is a “kick the can down the road” button that often has a high price.

These tools are not a “free pass.” They are a complex financial product with hidden costs that can add thousands of dollars to your loan and trap you in debt for even longer. This is the financial “help” that can end up hurting you.

Before you make that call, you need to understand the real difference between these two options and the one, critical “gotcha” that almost always comes with them.

What is Loan Forbearance? A Simple Definition

Loan forbearance is a temporary, agreed-upon pause or reduction in your monthly loan payments.

Think of it as a short-term truce with your lender. You call them and explain your hardship, and they agree to let you pay a reduced amount (or nothing at all) for a set period, typically 3, 6, or 12 months.

This is the most common option offered for mortgages, auto loans, and personal loans.

Here is the single most important part: During forbearance, the interest on your loan almost always continues to accrue (grow) every single day.

If you have a $300,000 mortgage at 6% interest, you are still racking up about $1,500 in new interest every month of your “pause.” You just aren’t paying it… yet.

What is Loan Deferment? A Simple Definition

Loan deferment is also a temporary pause in your payments. You are not required to make any payments during the deferment period.

This term is most common with Federal Student Loans. It’s also available for other loans, but it’s much rarer.

So what’s the difference? It all comes down to one word: Interest.

With deferment, the interest might be paid for you by someone else. This creates two very different types of deferment:

1. Subsidized Deferment (The “Good” Kind)

This is the only true “pause button” in all of finance. If you have a Subsidized Federal Student Loan, the U.S. Department of Education will pay 100% of your interest that accrues during your deferment period.

You pause your payments, and when you come back, your loan balance is exactly the same as when you left. This is available for specific situations like going back to school, unemployment, or economic hardship.

2. Unsubsidized Deferment (The “Risky” Kind)

If you have an Unsubsidized Federal Student Loan, a private student loan, or most other types of loans, your deferment works just like forbearance.

You pause your payments, but the interest clock keeps ticking. The interest grows in the background, and you are responsible for paying it all back.

Deferment vs. Forbearance: The Critical Difference You Can’t Afford to Ignore

Let’s put it side-by-side. For 90% of people (especially with mortgages or private loans), you will be offered forbearance or an unsubsidized deferment. Functionally, they are the same trap.

The takeaway is simple: Unless you have a Subsidized Federal Student Loan, pausing your payments means your loan balance is actively growing while you’re not looking.

The Real “Cost”: Understanding Capitalized Interest (The $10,000 Trap)

This is the “truth” from the title. This is the hidden financial monster that lenders don’t explain clearly. The problem isn’t just the accrued interest; it’s what happens after the forbearance ends.

This is called Capitalized Interest.

Capitalization is the process where all the unpaid interest that accrued during your pause is added directly to your principal loan balance, creating a new, larger principal.

This is the “reverse compounding” that works against you. You are now paying interest… on your interest.

A Simple, Terrifying Example:

Let’s see how a “helpful” 12-month pause can cost you thousands.

• Your Original Loan: A $50,000 student loan at a 6% interest rate.
• Your Situation: You lose your job and get a 12-month forbearance.
• The “Pause” Period:
  • Your 6% interest on $50,000 is $3,000 per year (or $250 per month).
  • During your 12-month “pause,” $3,000 of interest builds up in the background.
• The Forbearance Ends:
  • The lender takes that $3,000 in unpaid interest and adds it to your principal.
  • Your new loan balance is $53,000.
• The Aftermath:
  • Your new 6% interest charge is calculated on $53,000, not $50,000.
  • Your new interest is $3,180 per year, not $3,000.
  • Your monthly payment will be recalculated and will be higher for the rest of your loan’s life.

That one-year “pause” just cost you $3,000 plus all the new interest that $3,000 will generate for the next 10-20 years. This is how people stay in debt forever.

The Hidden Impact: How Deferment and Forbearance Affect Your Credit Score

This is the #1 question most people have: “Will this ruin my credit?”

The answer is a “yes and no” that you need to understand.

The Good News

If you properly arrange the forbearance or deferment with your lender, and they approve it in writing, your account will be marked as “In Forbearance” or “In Deferment.”

As long as you follow the agreement (which is usually not paying), the lender will continue to report your account as “Current” or “Paid as Agreed” to the credit bureaus.

This means a properly arranged pause will NOT hurt your FICO score. It does not count as a late payment or a delinquency.

The Bad News (The Traps)

There are two hidden ways this can still hurt you.

1. Just Stopping Payments (The Kiss of Death): If you are in trouble and you just stop paying without getting an official, written agreement, you are delinquent. After 30 days, your lender will report a missed payment, which can tank your credit score by 50-100 points. After 90 days, you’re on the road to default. This is the worst mistake you can make.
2. The “Lender’s Eye” Test: Your credit score might be fine, but your credit report still tells a story. When you apply for a new loan (like a mortgage) in the future, the new lender will see that you had a forbearance. It’s a red flag that you were in financial distress. This can make it much harder to get approved for new credit, as it makes you look like a higher risk, even if your “score” is good.

The Payback: What Happens When Forbearance Ends?

The “pause” is over, and your new, higher balance is here. Lenders don’t just forget about the money you were supposed to pay. You have to pay it back.

Your lender will typically give you three options:

1. Lump-Sum Reinstatement: You pay back all your skipped payments (plus that capitalized interest) in one giant payment. For a mortgage, this could be $10,000+. Almost no one in financial hardship can do this.
2. Repayment Plan: Your lender will spread the missed payments out over the next 12-24 months, on top of your new, higher regular payment. This can often make your new bill unaffordable.
3. Loan Modification: This is the most common option for mortgages. The lender takes all the missed payments and interest and tacks it onto the end of your loan. Your loan term is extended (e.g., your 30-year mortgage becomes a 31-year mortgage). This is often the most manageable option, but it also means you are paying even more in long-term interest.

Are There Alternatives? What to Do Before You Pause Payments

Deferment and forbearance are not your only options. They are a last resort. Before you pull that trigger, explore these alternatives first.

1. The Golden Rule: Call Your Lender, Immediately

This is not an “alternative,” this is the first step. Do not be scared or embarrassed. Lenders are not monsters; they are business people. It is far cheaper and easier for them to help you than to let you default and have to foreclose or repossess.

Call them, be honest, and say, “I am having a financial hardship. What are my options?”

2. Ask for a Loan Modification (A Permanent Fix)

Instead of a pause, ask for a permanent change.

• Lower Interest Rate: If your credit is still decent, they may be able to lower your rate, which lowers your payment.
• Extend the Term: They might be able to change your 5-year auto loan into a 7-year auto loan. Your monthly payment will drop significantly (though you’ll pay more interest long-term). This is often a better solution than forbearance.

3. Refinance or Consolidate

If your credit is still strong, you might be able to get a new loan to pay off the old one.

• Auto Loan Refinance: Find a credit union to refinance your car at a lower rate.
• Personal Loan: Use a fixed-rate personal loan to pay off high-interest credit cards.
• 0% APR Balance Transfer: This is a classic “deferment” for credit cards. You move your debt to a new card and pay 0% interest for 12-18 months.

4. Ask for Forbearance… With a Twist

If forbearance is your only option, ask for this: “Can I get a forbearance, but still make ‘interest-only’ payments?”

If you can just scrape together enough to pay only the $250 in interest that’s accruing each month, you can prevent capitalization. Your loan balance won’t grow. When the pause ends, your balance will be the same, and your payments won’t go up. This is the single best way to use forbearance safely.

Is Pausing Your Loan a Good Idea?

A deferment or forbearance is not a good idea, but it is a necessary one in an emergency.

It is 100% better than default, delinquency, and foreclosure. A forbearance is a scrape on your financial knee. A foreclosure is a broken leg.

Think of it as a life-saving but very expensive medicine. You should only take it when the illness (defaulting on your loan) is worse than the side effects (capitalized interest).

If you must use one, follow these rules to protect yourself:

1. Call your lender before you miss a payment.
2. Get the agreement in writing. A verbal promise is worthless.
3. If you can, try to pay the interest each month to prevent capitalization.
4. Understand your payback terms before the pause period ends.

These tools are a bridge over a financial canyon. They are designed to get you to the other side, but they are not free. They will charge you a “toll” in the form of capitalized interest. By knowing the cost, you can make the decision that’s right for you, not just the one that’s easiest for the bank.