How to Handle Federal Student Loan Default
During difficult financial times, student loan payments often get put on the back burner. By the time a borrower has their finances back under control, they may find that their student loans have gone into default. If this has happened to you, you are not alone; on average, 15% of student loans are in default at any point in time. The good news is that you have options for getting out of default and moving on with your financial life.
What is student loan default?
Federal student loan default occurs when a borrower fails to make a payment on their loan for 270 days (nine months). At that point, the full balance of the loan plus interest becomes due immediately.
Why should you deal with this?
Student loan default can have long-lasting effects, so it’s best to deal with it as soon as you have the financial means to do so. These effects include:
A negative impact on your credit score
Wage garnishment
Seizure of tax refunds
Potential to be sued
Loss of ability to qualify for additional federal student aid
What are your options for getting out of default?
Repay your loans in full: The simplest (but also most difficult) way to get your student loans out of default is to repay them in full.
Pros: If your loans are small enough or you recently received a large sum of money, this is the fastest way to get out of default. It has the added benefit of closing out your loans, so you won’t need to worry about making monthly payments going forward.
Cons: Unless you are sitting on a pile of disposable cash, this may not be a realistic option for you.
Rehabilitation: Student loan rehabilitation allows you to get your loans out of default by making nine monthly payments over a consecutive 10-month period. You must start by contacting your student loan servicer or the Department of Education. They will calculate a “reasonable” and “affordable” monthly payment based on your income. Once you’ve made those nine payments, your loans will be successfully rehabilitated and go back into repayment.
Pros: Rehabilitation comes with a unique benefit: once your loans are rehabilitated, the record of default will be removed from your credit report (although the history of missed payments preceding the default will remain). This can increase your credit score.
Cons: You only have one shot at rehabilitation so make sure you’re financially stable enough to commit to those payments. Having an emergency fund helps!
Consolidation: Consolidating involves combining multiple loans into a single loan with one interest rate and monthly payment.
Pros: Consolidating your loans can get them out of default more quickly than rehabilitation. As soon as your consolidation is complete, you can get started on repaying student loans. This typically takes 30-45 days.
Cons: If you have already consolidated your loans, consolidating again is not an option for you unless you have at least one other loan you can add. If your loans are being collected through wage garnishment or there is a court judgment against you, you must have those removed before you can consolidate. You are also limited to income-driven repayment plans unless you make three monthly payments before consolidating.
What first steps should you take?
Gather more information: To start the process of getting out of default, you’ll need to know who holds your loans and what type of loans you have. Start by creating an account with Federal Student Aid.
Estimate your potential payment: Use the Federal Student Aid loan simulator to estimate your payments post-consolidation or rehabilitation.
Analyze your budget: To feel comfortable with making your student loan payments again, you need to have a handle on your budget. After your current bills are paid and you’ve taken your other basic expenses such as groceries and transportation into account, will you have enough money to pay your loans?
Working through federal student loan default can be intimidating but it will ultimately help you take back control of your financial future. If your loans are currently in default, there is an added benefit to rehabilitating them now: because payments are suspended until May, any months between now and then will still count towards your nine required monthly payments without you actually having to pay!