Forbearance vs. Deferred Payment Plans: What’s Best for Your Financial Situation?
When financial hardships strike, managing payments for loans, mortgages, or credit cards can become challenging. Fortunately, lenders often offer relief options such as forbearance or deferred payment plans to help borrowers stay afloat. While both provide temporary relief, they differ in structure, impact on credit scores, and long-term financial implications. Understanding these differences can help you decide which option is best for your financial situation.
In this article, we’ll break down the key distinctions between forbearance and deferred payment plans, weigh the pros and cons of each, and offer tips for selecting the right option.
1. What Is Forbearance?
Forbearance is a temporary postponement or reduction of your loan payments, granted by your lender, often due to financial hardship. Forbearance agreements are typically short-term, ranging from a few months to a year, and are common with mortgages, student loans, and other long-term debts.
During forbearance:
- Your payments are either paused or reduced for a specified period.
- Interest may continue to accrue on the outstanding balance, depending on the loan type.
- At the end of the forbearance period, borrowers are required to resume regular payments and, in some cases, repay the missed payments through a lump sum or an extended payment plan.
Pros of Forbearance:
- Immediate Relief: Forbearance allows you to skip or reduce payments temporarily, easing immediate financial strain.
- Flexible Terms: Lenders may offer customized forbearance terms based on your specific financial situation.
- No Immediate Credit Impact: Lenders usually report forbearance agreements to credit bureaus, but missed payments during the forbearance period won’t be counted as delinquencies, so your credit score is not negatively affected during the agreed term.
Cons of Forbearance:
- Interest Accrual: While you may not be required to make payments, interest often continues to accrue. This means your overall debt can grow during forbearance, increasing the total amount owed.
- Repayment Pressure: At the end of the forbearance period, you must resume payments. In some cases, you may be required to pay a lump sum, which can be difficult if your financial situation hasn’t fully recovered.
2. What Is a Deferred Payment Plan?
A deferred payment plan allows borrowers to postpone payments entirely for a specified period, with the deferred payments added to the end of the loan term or spread out over future payments. Unlike forbearance, deferred payment plans often do not accrue interest during the deferment period, although this varies by lender and loan type.
During a deferment:
- Payments are paused, and sometimes interest does not accrue, depending on the agreement.
- The missed payments are typically added to the loan’s end, extending the term or spread out across future payments.
Deferred payment plans are common in student loans, mortgages, and auto loans, and are often used during natural disasters or economic crises, such as the COVID-19 pandemic.
Pros of Deferred Payment Plans:
- No Interest Accrual (in some cases): Depending on the loan agreement, deferred payment plans may not accrue interest during the deferment period, preventing your debt from growing.
- Flexible Repayment: Deferred payments are typically added to the end of your loan, making repayment more manageable compared to forbearance, where you might face a lump-sum payment.
- No Immediate Credit Impact: Like forbearance, deferred payments usually don’t negatively impact your credit score, as long as you adhere to the agreement.
Cons of Deferred Payment Plans:
- Not Always Available: Deferred payment plans may not be offered for all loan types. For example, some credit cards or short-term loans might not have this option.
- Extended Loan Term: While pushing payments to the end of the loan term offers relief, it also means you’ll be in debt longer, which could have implications for long-term financial goals.
3. How Do Forbearance and Deferred Payments Impact Your Credit Score?
Both forbearance and deferred payment plans can protect your credit score during periods of financial difficulty. Lenders often report accounts in forbearance or deferment to the credit bureaus, but these accounts are marked as “in forbearance” or “deferred”, signaling that missed payments should not be treated as delinquencies. However, it’s important to note:
- Credit Utilization: Even though your payments are paused, if your forbearance or deferred loan is tied to a revolving credit account (like a credit card), it can affect your credit utilization rate. High credit utilization—using more than 30% of your available credit—can lower your credit score.
- Lender Reporting: Always check with your lender to confirm how they will report your account status to the credit bureaus. If they fail to report correctly, you might see a negative impact on your score. For example, a loan in forbearance could still be marked as “past due” if not reported correctly.
Tip: Stay in touch with your lender and monitor your credit report during the forbearance or deferment period to ensure that everything is being reported accurately.
4. Deciding Which Option Is Best for You
Choosing between forbearance and deferred payment plans depends on your financial situation, the type of loan, and how long you anticipate needing relief. Here are some practical tips to guide your decision:
Choose Forbearance If:
- You need immediate short-term relief and expect your financial situation to improve relatively soon.
- You’re willing to handle interest accrual and understand that it may increase the total cost of your loan.
- You have a plan for repaying missed payments at the end of the forbearance period, whether through a lump sum or extended payment plan.
Example: John lost his job temporarily due to a factory closure and expects to be rehired within six months. He opts for forbearance on his mortgage to avoid falling behind, knowing he’ll have the ability to catch up on payments once he’s employed again.
Choose a Deferred Payment Plan If:
- You need longer-term relief, and your lender offers deferred payments with no or minimal interest accrual.
- You’re comfortable extending the length of your loan and prefer not to worry about lump-sum payments or steep interest increases after the relief period.
- You want more flexible repayment options, such as spreading the missed payments across future installments or adding them to the end of the loan.
Example: Maria’s restaurant has been struggling due to a natural disaster, and she doesn’t expect business to recover fully for at least a year. She chooses a deferred payment plan on her business loan, giving her time to rebuild without the pressure of immediate repayments.
Conclusion
Forbearance and deferred payment plans can both offer crucial relief during financial hardships, but it’s important to understand the differences before choosing the best option for your situation. Forbearance offers short-term relief with potential interest accrual, while deferred payment plans offer more flexibility and may avoid interest altogether.
By communicating early with your lender and considering how each option affects your credit and repayment terms, you can make an informed decision to safeguard your financial future.
Remember to stay proactive—whether you’re facing job loss, illness, or another form of hardship—and choose the plan that aligns with both your current needs and long-term financial health.
