How Interest Accrues During Auto Loan Deferment Periods

How Interest Accrues During Auto Loan Deferment Periods

Taking out an auto loan is often the only way many folks can afford to buy a car. Monthly payments make vehicles more accessible for the average consumer. But sometimes life happens and financial hardship strikes, making it difficult to pay those monthly installments; when this occurs, deferment may help — but it comes at a cost.

Deferring an auto loan payment means asking the lender to let you delay making the next payment, either partially or in full. Lenders may allow borrowers to defer one, two, or sometimes up to three months of payments if they are undergoing financial distress. This can provide much-needed temporary relief when money is tight.

However, it’s important to understand that interest continues accruing during the deferment period. The loan contract with the lender is typically structured as a simple interest loan — this means interest accumulates daily based on the remaining balance. So if payments are deferred, interest keeps building up and gets tacked onto the total amount owed.

When Can You Defer an Auto Loan Payment?

Deferment may be an option if you experience an unexpected financial setback such as:

• Job loss or reduction in income
• Unanticipated medical bills
• Family emergency
• Car repairs
• Natural disaster or weather event

Most lenders will want to see evidence of hardship before approving deferment. This usually involves submitting documentation like pay stubs, medical bills, insurance claims, etc. The lender will review this information and decide if a deferment is warranted.

How Do I Request a Deferment?

Here are some tips for seeking an auto loan deferment:

• Review your loan agreement – Some lenders build in an option to “skip a payment” or defer one monthly installment. This clause outlines the terms and conditions.
• Contact your lender – If deferment is not mentioned in your contract, call and explain your situation. Ask about their hardship programs and policies.
• Send a hardship letter – Most lenders require this written explanation of why you need deferment and when you will be able to resume normal payments.
• Provide documentation – Supply evidence like pay stubs, medical forms, insurance papers, etc. to back up your hardship claim.
• Get approval in writing – Before skipping any payments, get written approval from the lender confirming the deferment terms.

Deferment vs. Forbearance

Deferment is often confused with forbearance. While both allow you to temporarily pause or reduce payments, there are some key differences:

• Deferment – Lets you delay payments but interest keeps accruing. You eventually have to pay the skipped payments plus interest.
• Forbearance – Also lets you delay payments but interest accrues and gets tacked onto the loan’s principal. This increases the total amount owed.

Forbearance is more commonly used with federal student loans and mortgages. Auto lenders rarely offer forbearance programs. Deferment is the most likely option for delaying car payments.

How Does Interest Accrue During Deferment?

When payments are deferred, interest continues accumulating based on the unpaid balance. Here is how it works:

• Interest accrues daily – Most auto loans use the simple interest method, meaning interest builds up each day.
• Deferred payments get added to balance – If you skip payments, those amounts are tacked onto the total owed.
• Interest is calculated on new higher balance – With a bigger unpaid balance, more interest accumulates each day.
• Interest gets added to amount due – All the interest that built up during deferment eventually has to be repaid along with the deferred payments.

For example: you defer 2 monthly payments of $200 on a loan with a 10% APR. Over those 2 months, about $33 in interest accrues. Once the deferment period ends, you owe the 2 deferred payments ($400) plus the $33 in interest. Your balance to be repaid is now $433 higher.

Pros and Cons of Deferment

Deferring payments can be a lifeline if you’re struggling to make ends meet. But it also has some downsides. Consider the key pros and cons before pursuing deferment:

Pros

• Gives temporary financial relief
• Prevents late fees and penalties
• Avoids damage to credit score
• Allows time to recover from hardship

Cons

• Interest keeps accruing
• Increases total repayment amount
• Lengthens the loan term
• Delaying payments increases total interest paid

Deferment can be a double-edged sword – it provides immediate payment relief but causes more interest to accrue, costing more in the long run. Carefully weigh the tradeoffs before pursuing this option.

Alternatives to Deferment

If you don’t want to defer payments, here are some other options to discuss with your lender:

• Lower monthly payment – They may agree to a lower amount for a few months if evidence of hardship is provided.
• Interest-only payments – Making payments on just the interest can help avoid deferred payments piling up.
• Extension of loan term – Adding extra months to the loan duration lowers the monthly payments.

You may also look into refinancing your auto loan to reduce the monthly payment. Compare interest rates across multiple lenders to find the best terms.

Impact on Credit Score

Deferred payments can affect your credit score in a few ways:

• Late payments are avoided – This prevents damage to your credit history and score.
• Total debt amount increases – Higher loan balance from accrued interest can negatively impact credit utilization ratio.
• Length of credit history expands – Extending the loan term preserves the age of the tradeline.

Overall, a short deferment is unlikely to hurt your credit significantly. But repeated or lengthy deferments that bloat your balance can be problematic. Keep the deferment as brief as possible to limit the impact on your credit profile.

Other Financial Tips

Besides deferment, here are some other tips for managing finances through a period of hardship:

• Build up emergency savings – This provides a buffer to cover essential expenses if income is disrupted.
• Prioritize bills – Pay necessities like housing, utilities, food first.
• Seek loan modifications – Ask creditors about reducing payments or waiving fees.
• Use credit counseling agencies – They help negotiate with creditors and create debt repayment plans.
• Cut discretionary spending – Limit expenses on wants vs. needs.
• Use community resources – Local food banks, charities, and government programs can help.

Learning budgeting strategies and improving money management skills can help you weather financial storms without having to defer loan payments.

The Bottom Line

Deferring an auto loan payment may be necessary if you experience a setback that makes it difficult to pay your monthly installments. But interest continues accruing during the deferment period, leading to a higher remaining balance and increased total interest paid over the loan term.

Carefully consider all alternatives before pursuing deferment and keep the deferment period as brief as possible. This can provide temporary relief while minimizing the financial impact on your auto loan.