Should You Consider a Loan Payment Deferral?

Should You Consider a Loan Payment Deferral?

A loan deferral allows you to temporarily suspend your loan payments when facing financial difficulty. While deferrals provide short-term relief, they come with long-term costs and consequences you need to understand before requesting one from your lender.

What is a Loan Payment Deferral?

A loan deferral is a formal agreement with your lender that pauses your regular loan payments for a specific period. Your lender agrees not to collect payments until the deferral period expires, at which point payments must resume. During this pause, interest continues to accumulate on your outstanding balance, which means your loan balance will be higher when payments restart on the agreed-upon date.

While some loans have built-in “skip-a-payment” features for occasional use, a loan deferral is different. Skip-a-payment programs are typically one-time arrangements for a single month. In contrast, a loan deferral is a more structured arrangement that can last several months and is designed to help borrowers experiencing genuine financial hardship.

It’s crucial to understand that a loan deferral is not debt forgiveness. You still owe the full amount of your loan, plus any interest that accumulates during the deferral period. Think of it as pressing pause on your payments rather than eliminating them.

How Do Loan Deferrals Work?

Most Canadian financial institutions offer payment deferrals for periods ranging from one to six months. During this pause, interest continues to accumulate on your outstanding balance, but you don’t make any payments. The deferred payments are added to your loan which means your balance will be higher when payments restart on the agreed-upon date.

When you arrange a deferral, your lender will explain how the deferred payments will be handled when the deferral ends. This might involve increasing your regular payment amount, extending your loan term, or making a lump sum payment to cover the deferred amount.

A deferral can take the pressure off your budget, and help you pay for necessities like rent and groceries and reduce the risk that you technically default on your mortgage or loan. However a loan deferral program does come with some downsides.

The Cost of Deferring Loan Payments

With a payment deferral you are trading short-term relief for increased long-term costs:

  • Interest continues accumulating during the deferral period
  • Your loan balance grows while payments are paused
  • Monthly payments may increase when they resume
  • Your loan term may be extended, increasing total interest paid
  • You’ll need to make up missed principal payments

For example, deferring payments on a $300,000 mortgage at 5% interest for six months would add approximately $7,500 to your loan balance. This could increase your monthly payments by $50 or extend your mortgage term.

How Loan Deferrals Affect Your Credit Score

A properly arranged loan deferral should not hurt your credit score. When you make a formal agreement with your lender, they should report your payments to credit bureaus as “deferred” rather than as late or missed payments. This special reporting status protects your payment history, which is the most important factor in determining your credit score.

However, there are indirect ways a loan deferral can affect your credit profile. Since interest continues to accumulate during the deferral period, your loan balances will increase. This higher balance will impact your credit utilization ratio – the amount of credit you’re using compared to your available credit. A higher utilization ratio can temporarily lower your credit score.

You should also consider that multiple requests for loan deferrals may affect future credit applications. While a single deferral during a period of financial hardship is generally viewed as responsible debt management, repeated deferrals might signal ongoing financial difficulties to future lenders.

Always get written confirmation of your deferral agreement and keep this documentation. If you notice any errors in how the deferral is reported on your credit report, you’ll need this documentation to dispute the error with both your lender and the credit bureaus.

What Types of Loans Can Be Deferred?

Mortgage Deferrals

Your mortgage lender may allow you to defer payments temporarily if you’re experiencing temporary financial hardship. The deferred amount, including principal and interest, is typically added to your mortgage balance. This results in either higher monthly payments or a longer amortization period when payments resume.

To qualify your mortgage must be up to date and in good standing – meaning no missed mortgage payments. You may have to continue making applicable property tax or creditor insurance payments.

Credit Card Payment Deferrals

Since the pandemic, general credit card debt deferrals are much less common in Canada. However, what have become increasingly popular is the option to convert select charges to an installment plan. Programs like CIBC Pace It, Scotia Select Pay or TD Payment Plans provide the option to convert eligible purchases into equal monthly payments. While this might delay repayment, you are still required to make a payment each month. Charges can be converted for an upfront fee (up to 2% of the purchase amount) and will be charged a reduced interest rate.

Car Loan Deferrals

Auto lenders typically extend your loan term by the number of months deferred. While this keeps your payment amount the same, you’ll pay more interest over the life of the loan. Some lenders may require a lump sum payment of deferred amounts when payments resume. Be prepared to explain the specifics of your situation before you apply.

While a deferral can provide temporary relief and help avoid immediate repossession of your vehicle, it’s only a short-term fix that doesn’t address the underlying issue if you’re struggling with car loan payments.

Student Loan Deferrals

Government student loans have formal repayment assistance programs that can include reduced payments. Private student loan deferrals depend on your lender’s policies. While the federal government no longer charges interest on student loans, some provinces still do. Extending your student loan repayment will mean you will pay more interest over time.

Personal Loan Deferrals

Banks and other lenders may offer deferrals on personal loans, lines of credit, and other credit products. Terms vary significantly between institutions and loan types.

Is Taking a Loan Deferral a Bad Choice?

A loan deferral is not inherently good or bad – it’s a financial tool that can help you manage temporary financial difficulties. While deferrals do increase your overall debt through accumulated interest, they can be a responsible choice when used appropriately.

The key is understanding when to use a deferral. It’s a good option when you:

  • Are facing a temporary financial setback
  • Have a clear plan for resuming payments
  • Understand the additional costs involved
  • Have explored other options like restructuring payments

However, deferrals should not be used as a long-term solution to ongoing financial problems. If you’re consistently struggling to make payments, you likely need a more permanent debt solution like debt consolidation or a consumer proposal.

Taking a loan deferral is certainly better than missing payments entirely. It can help you avoid immediate damage to your credit score, late payment fees and collection actions from late payments.

Need Help Deciding About a Loan Deferral?

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How to Request a Loan Deferral

Many major banks and lenders now offer payment deferral requests through their online banking platforms or mobile apps. This digital option can make the process faster and more convenient, especially for simple deferrals or skip-a-payment arrangements.

However, if you’re experiencing serious financial hardship or need a longer deferral period, it’s best to speak directly with your lender. Follow these steps when requesting a loan deferral:

  • Contact your lender before missing any payments
  • Explain your financial hardship and why you need the deferral
  • Ask about all terms, including how interest and missed payments are handled
  • Get the agreement in writing, including how it will be reported to credit bureaus
  • Understand when and how payments will resume

Whether applying online or speaking with a representative, make sure you fully understand the terms of your deferral agreement and keep copies of all documentation.

Alternatives to Deferring Your Loan Payments

Refinancing at a Lower Rate

When facing financial difficulties, refinancing your loan could provide immediate relief through reduced monthly payments. By securing a lower interest rate, you can decrease your payment obligations while continuing to pay down your debt. This option works best if your credit score has improved since your original loan or if market rates have decreased.

Restructuring Over a Longer Term

Extending your loan term can make your monthly payments more manageable by spreading them over a longer period. While this means you’ll pay more in total interest over time, it can provide the breathing room you need in your monthly budget while keeping your loan in good standing.

Interest-Only Payment Schedule

Switching to an interest-only payment schedule temporarily reduces your monthly obligations by allowing you to pause principal payments. This option keeps your loan current and prevents the balance from growing while providing short-term relief. However, remember that you’re not reducing your loan balance during this period.

Modified Payment Plan

Many lenders offer customized payment plans that can include both reduced and paused payment schedules. These modifications provide flexibility while avoiding complete deferral. Working directly with your lender to create a modified plan often has less impact on your credit score than other options and can be tailored to your specific financial situation.

Debt Consolidation

Consolidating multiple debts into a single loan can simplify your finances and potentially reduce your overall monthly payment. This approach combines various debts under one interest rate and payment schedule, making it easier to manage your obligations. It may also result in a lower overall interest rate if you qualify.

Professional Debt Relief Solutions

If you’re facing more serious financial challenges, speaking with a Licensed Insolvency Trustee can help you understand more comprehensive debt relief programs. These professionals can assess your complete financial picture and recommend structured solutions that go beyond temporary payment adjustments, potentially including consumer proposals or other formal debt relief options.

Before choosing any alternative, carefully consider the long-term financial implications, including total interest costs, credit score impact, and alignment with your financial goals. 

If your considering deferring so much debt that you can’t see yourself paying back your balances, consider talking with a Licensed Insolvency Trustee about making a deal with your creditors to repay what you can.

Similar Posts:

  1. What To Do if You Can’t Pay Deferred Mortgage Payments
  2. Making Extra Loan Payments More Important Than Ever
  3. What To Do If Your Mortgage Is In Arrears
  4. Should I Get A Debt Consolidation Loan? Pros and Cons
  5. Can’t Pay Your Mortgage? Options To Keep Your House

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