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How loan deferment works

Take a closer look at what’s happening when student loans are in deferment . Created by Sal Khan.

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  • duskpin ultimate style avatar for user Dylan Montgomery
    Is loan deferment recommended?
    (5 votes)
    Default Khan Academy avatar avatar for user
    • starky ultimate style avatar for user Sienna
      I know I'm late, and also that I don't have expertise in this area, but here's what I think:

      When you defer the loan, it makes it to where the amount you have to pay doesn't start to increase by x% and to where you don't have to start paying immediately. So, if you're having trouble finding a job after college or are only able to get a low-income job (e.g. minimum wage or lower), you are not required to pay the loan at that time. You also don't have the stress of knowing that the loan is increasing due to interest and that you don't have the means to pay it.
      (3 votes)

Video transcript

When you borrow money or take out a loan, there's one of two situations. There's one situation where you need to pay interest immediately. So let me write that as pay interest interest immediately, immediately. And then there's another situation where you are allowed to defer the interest. Defer the interest over some period of time. And even in those situations where you are allowed to deffer the interest, there's some situations where it is subsidized, subsidized, essentially someone is making your interest payments for you during that deferral period, and then there's other situations where it is unsubsidized. Unsubsi, subsidized. Unsubsidized. Now, in the world of student loans, we typically think most student loans fall into the category of deferred interest, because whoever's lending it to you, whether it's the government or oftentimes even a private bank, they understand that while you are in school you do not have a job, and so you are unlikely to be able to make payments. So this tends to be the case. This tends to be the case for student loans, for student loans. And the period of deferment tends to be while you are a student, because they recognize that you are still in school, and sometimes there is a grace period after that, and then there's sometimes even a potential for deferment of interest payments if you're going through some type of hardship, if you are on unemployment or whatever else. But there's typically at minimum a deferment while you are a student. And there's different thresholds, depending on the loan that you're looking at, on how much of a student you have to be. Do you have to be full-time? Do you have to be part-time, or whatever else it might be. But to understand how deferment works and what subsidized versus unsubsidized would look like, I'll use an example. So the typical example for a subsidized loan, and a subsidized loan will, at least in all the cases I can think of, will almost explicitly come from the government. So these come the government, from the Department of Education. And these tend to be for students who quality for financial aid, especially at the undergraduate level. So let's look at the example of a subsidized loan. Subsidized. Subsidized loan, and as the example I will use the Direct, Direct subsidized loan from the federal government. It's literally called the Direct subsidized loan. Subsidized, subsidized loan. And then just as to compare it, we will also look at, as an unsubsidized loan, maybe I don't have to keep writing this word, subsidized, unsubsidized. We'll look at the Direct unsubsidized, subsidized loan. Unsub... sidized, unsubsidized loan. Unsubsidized loan. And once again, you get this. This is at the undergraduate level. If you qualify for financial aid. This is, this could be more general than just that. It could happen for, I won't go into all of them. The whole point here is to understand the impact of being able to have a subsidy on your deferred interest over some period of time. And so let's say that in your freshman year, in that first, I guess, when you have to pay that first round of tuition, let's compare the difference between taking a Direct subsidized loan of $1,000. Once again, not everyone qualifies this, but this is just to give a sense of what happens to the interest over while you are deferring it, versus taking $1,000 of Direct unsubsidized loan. And let's say in either case you are allowed to defer it over the period that you're a student, and let's say that happens over the next four years. And there tends to be some maximum cap on how long you can defer it, and they tend to be a little bit longer than four years. For things like subsidized and unsubsidized loan we're looking at six years, but you should obviously look at the special cases, and these things change, so you should definitely look at the specifics to whatever you are borrowing. But let's say, just remember, this is just for that first period. You're gonna probably keep borrowing. Probably the second semester you'll borrow some more, then next year you're gonna borrow some more. But let's just say that first, that first disbursement that you get, you defer it in either case until you graduate. And let's say, let's not even think about the grace period. Let's just think about what you owe after four years. So this is four years goes by in either situation. Four years go by. Now, in the Direct subsidized loan, you don't have to pay it for four years, and you don't have to pay the interest on it for four years. And the interest is essentially being subsidized, it's being paid for by the federal government. So after the deferral period, how much do you owe? You still owe $1,000. Now, what happens on the Direct unsubsidized loan? Well here, you don't have to pay the loan down and you don't have to pay the interest for four years, but that interest is accumulating and it is compounding. It is being added to what you actually owe. So let's say in either case the interest, and once again, it's going to be different depending on when you actually get your loan. Let's say in either case we're looking at a 4.66% annual interest rate. So how much, if we accumulate at 4.66% annual interest, how much are we going to have to owe at the end of four years of this situation? To answer that question, we can do a little bit of mathematics. So if you have 4.66% per year, if you want the daily compounding rate, because these things compound on a daily basis, so 0.0466. And once again, you should check what your interest rate actually is. I'm just using this as an example. And then we take the mathematical average of the number of days you have in a year, if you average out the leap years and the regular years, you get 365.25 days in a year. So you have 1.27583, so on so forth, times 10 to the negative four, which is the same thing as 0.00012758, and you can go on and on and on. Had to keep pausing this video while I sneeze. I didn't want you to have to deal with the sound of that. Anyway, where was I? So this is the same thing as 0.00127 on and on and on, per day. This is your daily compounding. So over four years, how many days are there? It's gonna be 365.25 times four. So essentially how much are you going to have to pay? How much is going to be the capital that you're going to owe, or the principal, I guess you should say? The $1,000 times, now, you are going to compound by one plus this amount. So I'm just gonna do second and answer, so that means my previous answer. So one plus that amount is how much you're compounding per day, and how many days are there over four years? So it's gonna be four years times 365.25 days per year. So once again, this is the number of days in four years, so it's gonna be over 1,000 days, over 1,200 days actually. You get the idea, it's over that many days, and you're compounding this much each day, so you're essentially multiplying this number that many times, times 1,000. And so this is gonna give us how much we're gonna owe with that interest. We didn't have to pay it. It's being deferred, because we're students, we can't pay it right now, but how much are we gonna owe after the deferment period? So it's gonna be 1,204.88. Well, if we round, 89 cents. So we are going to owe, we are going to owe, $1,204.89 if you round up. So hopefully this can give you a little bit of appreciation for how powerful this part right over here is. Over here, we're owing over 20% more deferring over those four years. And this is just for $1,000, well, it's gonna be 20% regardless of this amount right over here, but this is for our first loan. Now, when we take a loan in junior year, you're gonna be deferring it for less time, so you're going to accumulate less interest, but it's giving you the value of what this subsidy is, at least for that first $1,000 that you are deferring for four years. You're saving over $200 of interest by getting the subsidized loan. Now, once again, not everyone can get the subsidized loan, but if you can, hopefully you appreciate its value right over here.