Student Loan Grace Period

A student loan grace period is the interval between leaving school and the first payment falling due. The federal definition is at 34 CFR 685.102(b), which calls it "a six-month period that begins on the day after a Direct Subsidized Loan borrower, a Direct Unsubsidized Loan borrower, or, in some cases, a Direct Consolidation Loan borrower whose consolidation application was received before July 1, 2006, ceases to be enrolled as at least a half-time student at an eligible institution and ends on the day before the repayment period begins". Note which loans that list includes and which it does not: the two Stafford loans, and a narrow historical class of consolidation loans.

The phrase is worth qualifying because it names at least four unrelated things in personal finance. A credit card grace period is the window in which purchases from the last statement can be repaid without interest. An insurance grace period is the time a policy stays in force after a missed premium. A certificate of deposit and a retirement plan each have their own. Only the student-loan one is a delay before repayment starts, and it is the only one of the four that can be used up.

One grace period per loan, and this is the least known and most consequential rule on the subject. Both 34 CFR 685.207(b)(2)(i), for subsidized loans, and 685.207(c)(2)(i), for unsubsidized, provide that when a borrower ceases to be enrolled on at least a half-time basis, "a six-month grace period begins, unless the grace period has been previously exhausted". A borrower who leaves school, runs the six months out, then re-enrolls and later leaves again does not get a second one: the second departure puts the loan straight into repayment. What re-enrollment does provide is an in-school deferment under 34 CFR 685.204(b), which the Department processes automatically when it receives enrollment information from the school under (b)(2)(ii) to (iv), and which the borrower may cancel under (b)(3)(i) if they would rather keep paying. That is the right tool for the situation, but it is a deferment rather than a fresh grace period, and the distinction matters because the final departure will have no cushion in front of it.

What interest does during the six months, by loan type. On a subsidized loan the borrower "is not obligated to pay interest ... during grace periods" under 685.207(b)(3)(ii), so the loan enters repayment at the amount borrowed. There is one cohort exception, and it still affects people repaying today: 685.207(b)(3)(iii) provides that for a Direct Subsidized Loan "for which the first disbursement is made on or after July 1, 2012 and before July 1, 2014, a borrower is responsible for the interest that accrues during the grace period". On an unsubsidized loan the borrower is responsible throughout, and 685.207(c)(3) adds that interest which accrues "may be capitalized or paid by the borrower", so an unsubsidized borrower who does nothing enters repayment owing more than they borrowed. During the grace period itself neither type requires principal payments, under (b)(2)(iii) and (c)(2)(iii).

PLUS loans have no grace period, and what they have instead is not as good. Under 34 CFR 685.207(d), "the repayment period for a Direct PLUS Loan begins on the day the loan is fully disbursed", and interest begins to accrue on the day of first disbursement. The regulation supplies a substitute at 685.204(c)(1)(i), under which a student PLUS borrower "is eligible for a deferment on a Direct PLUS Loan first disbursed on or after July 1, 2008 during the six-month period that begins on the day after the student ceases to be enrolled on at least a half-time basis", and (c)(1)(ii) rolls that period into an in-school deferment the Department has already granted. A parent PLUS borrower may request the same six months under (c)(2)(ii), and separately request a deferment while the student is enrolled under (c)(2)(i). The difference from a grace period is the interest treatment: 685.204(a)(2) provides that for a PLUS borrower in deferment, "interest does accrue and is capitalized or paid by the borrower". So the six months exist, they are described as a grace period by nearly everyone, and they are a deferment that adds to the balance.

Consolidating during the grace period ends it. 34 CFR 685.207(e)(1) provides that for a Direct Consolidation Loan "the repayment period ... begins and interest begins to accrue on the day the loan is made". Since consolidation pays off the underlying loans, the grace period on those loans stops with them. A borrower who consolidates in month two of grace has traded the remaining four months for an immediate repayment obligation, which is occasionally the right trade and never an accident worth making.

Two situations the regulation handles specially. A reservist called or ordered to active duty for more than 30 days "is entitled to have the active duty period excluded from the six-month grace period", including the time needed to resume enrollment at the next regular enrollment period, with any single excluded period capped at three years; and a borrower already in a grace period when called up "is entitled to a full six-month grace period upon completion of the excluded period" under 685.207(b)(2)(ii). For a correspondence student, 685.207(f) starts the clock on the earliest of the day after completing the program, the day after withdrawal as determined under 34 CFR 668.22, or 60 days after the school's own deadline for completing the program.

What the grace period is not. It is not a payment holiday a borrower can request, because it runs automatically from an enrollment fact. It is not a status a servicer grants, so there is nothing to apply for. And it is not a period in which nothing is happening: on an unsubsidized loan the balance is growing, and the last month of it is when the servicer will send the first billing statement, which is the practical reason to log into the servicer's portal early in the six months rather than late.

The school reports that the borrower has dropped below half-time enrollment. The day after that, the six-month clock starts on each Direct Subsidized and Direct Unsubsidized Loan that has not already used its grace period. During the six months no principal payment is required, and on an unsubsidized loan interest accrues. The servicer sends a billing statement before the period ends, and the first payment is due within 60 days of the beginning of the repayment period under 685.207(a)(3), which itself begins the day after grace ends. A borrower who wants an income-driven payment should apply during the grace period rather than after it, so that the first bill is the right size.

A hypothetical illustration of what the six months cost on an unsubsidized loan. A borrower leaves school with $27,000 of unsubsidized principal at a 6 percent annual rate. Simple interest for half a year is $27,000 times 0.06 times 0.5, which is $810. Pay it during the grace period and repayment starts on $27,000. Let it capitalize and repayment starts on $27,810, and every future interest calculation runs on the larger figure. On a subsidized loan of the same size the $810 is paid by the government instead, which is the entire practical difference between the two loan types during these six months, and the reason the 2012 to 2014 cohort is worth checking for anyone who borrowed then.

Pros

• It is automatic. Nothing has to be requested, granted or documented, because it runs from the enrollment record.
• It gives a new graduate six months to find work and build a small cash buffer before a fixed obligation starts.
• On a subsidized loan it is genuinely free, since the government pays the interest and the loan enters repayment at the amount borrowed.
• It is the right window in which to choose a repayment plan and, where relevant, apply for an income-driven one, so that the first bill is already the correct size.

Cons

• There is only one per loan, and a borrower who uses it up during an interruption has nothing left for the final departure.
• On an unsubsidized loan it is not free. Interest accrues throughout and capitalizes if unpaid, so the balance entering repayment exceeds the amount borrowed.
• PLUS loans do not get one, and the six-month deferment that substitutes for it capitalizes interest.
• Consolidating during it forfeits the remainder, because a consolidation loan enters repayment on the day it is made.
• It is not a hardship tool, so a borrower who needs longer has to move to a deferment or a forbearance with their own conditions and their own interest consequences.