The deferment period is a time during which a borrower does not have to pay interest or repay the principal on a loan. Deferment period also refers to the period after the issue of callable security during which the issuer can not call the security.
Breaking Down a Deferment Period
The deferment period applies to student loans, callables, some types of options, and benefit claims in the insurance industry.
Deferment Period on Loans
The deferment period is common with student loans and may be granted while the student is still in school or just after graduation when the student has few resources to repay the loan. Deferment may also be granted at the lender's discretion during other periods of financial hardship to provide temporary relief from debt payments and an alternative to default.
Usually, a newly established mortgage will include a deferment of the first payment. For example, a borrower who signs a new mortgage in March may not have to start making payments until May.
During a loan's deferment period, interest may or may not accrue. Borrowers should check their loan terms to determine whether a loan deferment means they will owe more interest than if they did not defer the payment. With student loans being federal loans, they do not accrue interest during the deferment period, but private loans typically do.
Deferment Period on Callable Securities
Different types of securities may have an embedded call option allowing the issuer to buy them back at a predetermined price before the maturity date. These securities are referred to as callable securities. An issuer will typically “call” bonds when prevailing interest rates in the economy drop, providing an opportunity for the issuer to refinance its debt at a lower rate. However, since early redemption is unfavorable to bondholders who will stop receiving interest income after a bond is retired, the trust indenture will stipulate a call protection or a deferment period.
The deferment period is the period of time during which an issuing entity cannot redeem the bonds. The issuer cannot call the security back during the deferment period, which is uniformly predetermined by the underwriter and the issuer at the time of issuance. For example, a bond issued with 15 years to maturity may have a deferment period of 6 years. This means investors are guaranteed periodic interest payments for at least 6 years, after which the issuer may choose to buy back the bonds depending on interest rates in the markets. Most municipal bonds are callable and have a deferment period of 10 years.
Deferment on Options
Another type of option, called the Deferment Period Option, has all the characteristics of an American vanilla option. The option can be exercised anytime before it expires; however, payment is deferred until the original expiration date of the option.
Deferment in Insurance
Benefits are payable to the insured when s/he becomes incapacitated and is unable to work for a period of time. The deferred period is the period of time from when a person has become unable to work until the time that the benefit begins to be paid. It is the period of time an employee has to be out of work due to illness or injury before any benefit will start accumulating, and any claim payment will be made.