Deferment Period

Definition

The deferral period refers to the time during a loan when the borrower is not required to pay interest or repay the principal. It can also refer to the period after the issuance of callable securities during which the issuer cannot recall the securities. The duration of the deferral period can vary depending on the terms agreed upon in the contract.

Origin

The concept of the deferral period originated from the need for flexibility in financial contracts, particularly in areas like student loans and municipal bonds. As financial markets evolved, the deferral period became a common financial tool to help borrowers and issuers better manage cash flow and risk.

Categories and Features

The deferral period is mainly categorized into loan deferral periods and security deferral periods. Loan deferral periods are typically used in student loans, allowing students time to find employment before starting repayment. Security deferral periods are common in municipal bonds, allowing issuers not to recall bonds for a certain period, thus reducing financing costs. Both types provide a time buffer but may lead to higher long-term costs.

Case Studies

A typical case is the U.S. federal student loans, which often offer a deferral period of up to three years, allowing students time to find employment after graduation before starting repayment. Another case is municipal bonds, such as those issued by New York City, which often have a 10-year deferral period, allowing the city government not to recall bonds during this time, thus reducing short-term fiscal pressure.

Common Issues

Investors might encounter issues such as underestimating the repayment pressure after the deferral period ends and overlooking the potential increase in long-term costs due to the deferral period. A common misconception is that the deferral period equates to debt forgiveness, whereas it merely postpones the repayment.