Q: Can you rehabilitate private student loans in default?

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Stanley tate

Student Loan Lawyer

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After all those years of deferment, forbearance, and interest rate reduced student loan payments, your loan balance has ballooned.

You looked into private student loan forgiveness.

Nope.

You looked into refinancing to get a new loan with new loan terms.

Be serious. Who's going to refinance you when you can't make you're struggling with your current loan repayment schedule?

Your loan holder or loan servicer refuses to work with you.

They're often rude AF.

Now they're saying unless you make the payment amount they're demanding, you'll be in default, and they'll send your account to a debt collector.

Sound familiar?

Thankfully, there may soon be a way to get your private student loans out of default: private student loan rehabilitation.

What is Loan Rehabilitation

First things first, let’s answer the question:

What is loan rehabilitation?

At bottom, loan rehabilitation is a process that allows you to bring a defaulted student loan out of default and back into a current repayment plan.

You can have a loan rehabilitation program for a car, home, cell phone, etc.

Basically, if you borrowed a loan and you later default on it, you may be able to bring it back into good standing by entering into a loan rehabilitation program.

What is Student Loan Rehabilitation

Simply put, student loan rehabilitation is a process that allows you to get a defaulted loan out of default by making a series of on-time payments.

As of now, this exists mostly for federal student loans.

Most private student loans don’t yet have a formal process that lets you rehabilitate a defaulted loan back into good standing.

But that may be changing.

The GAO Pushes for Private Student Loan Rehabilitation

Okay, so push may be the wrong verb.

In a recent report to Congress, the Government Accountability Office made clear that there’s no reason why student loan borrowers should not have access to a private student loan rehabilitation program.

As of Jan. 2019, none of the 5 banks with the largest private student loan portfolios offered rehabilitation programs for defaulted loans.

Why not?

The most common reasons the private lenders gave were:

  1. Private student loans have low delinquency and default rates
  2. They already offer alternative repayment options such as forbearance
  3. They’re unsure of how loan rehabilitation would work since they sell defaulted loans to debt purchasers and debt collection companies
  4. Concern that a loan rehabilitation program would make borrowers more likely to avoid alternative repayment options or default
  5. Concern a private lender would violate certain unfair and deceptive acts and practices laws because they couldn’t accurately describe the program’s benefits to a borrower (i.e., credit score improvement)

Two other concerns raised by nonbank private lenders (think agencies like New Jersey Higher Education Authority and MOHELA) were:

  1. The law that authorizes private student loan rehabilitation programs doesn’t grant them authority to remove negative information from credit reports and
  2. The law doesn’t define a private student loan default

That last part is interesting because the GAO points out that neither of the 3 major credit bureaus (Experian, Equifax, and TransUnion) uses the term default in credit reporting for private student loans.

Instead, private student loan lenders use different status codes to indicate they do not anticipate being able to recover losses on the loan.

Of course, this is totally different from loans owed by the Department of Education. Federal loans (Direct Loans, Perkins Loans, Direct Consolidation Loans, etc.) have a clear definition for default.

You're in default on a federal student loan when you go more than 270 days without making a required a payment on your loan.

Why Defaulted Private Student Loan Rehabilitation Should Exist

Here’s the deal:

There’s no good reason why defaulted private student loan rehabilitation shouldn’t exist.

The GAO argued in its report that private lenders that participate in such a program would face a minimal additional risk for several reasons:

  • The education loans being rehabilitated would already be considered a loss
  • The private loan default rate is low (it was less than 3 percent from Q2 2014 through Q3 2018)
  • Most private student loans have cosigners and those cosigners likely can help the borrower make their monthly payments under a rehab program

How Would Private Student Loan Rehabilitation Work

So let’s assume private student loan rehabilitation was a thing.

The natural question to ask then would be: what would private student loan rehabilitation actually do?

Unfortunately, there’s not a great answer to that question.

Flowchart of private student loan rehabilitation

What we know for sure is that the program would remove a default status from your credit report one-time.

While that sounds great, the reality is that it’s unlikely to have a massive impact on your credit score.

In a simulation of over 1 million borrowers with student loan debt, the GAO saw that for just one education loan default, the average borrower experienced a 60 point drop in their credit score.

You want to know how much their credit score increased by having the default status removed?

8 points on average. 11 points at best.

Credit score model after student loan rehabiliitation

That meager benefit makes sense when you think about what loan rehabilitation actually does.

It simply removes the default status from a credit report.

It doesn’t remove the late payments.

And those late payments are what really cripple your score.

For example, two of the credit bureaus said they give student loans a lower weight than other types of consumer loans in their generic credit scoring models. 

They suggested the lower weight was because student loan debt proves to be less important statistically at predicting credit risk

Pros and Cons of Loan Rehabilitation Programs for Private Student Loans

There are 3 main benefits to a private loan rehabilitation program:

  1. Stopping wage garnishments by nonbank state lenders
  2. Stopping debt collection efforts
  3. Allowing borrowers to keep their other non-student loan account in good standing.

For most private loans, you can't be garnished until you're sued and the private lender or collections agency gets a judgment against you. Federal loans are different. They can garnish your wages, take your tax refund, offset your social security benefits, and add a bunch of collection fees to your loan without suing you.

The cons of the program are:

  • You risk restarting the statute of limitations on debt collections
  • You may increase the likelihood that negative credit information will stay on your credit history
  • You lack income-based repayment options after you get out of default, which may lead to you defaulting a second time on the same loan.

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Hey, I’m Tate.

I'm a student loan lawyer that helps people like you with their federal and private student loans wherever they live.

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