Student loan default is a growing problem affecting about 15% of all student loans at any given time. While coronavirus relief measures halted most student loans from entering default, many borrowers already had student loans in default before the pandemic started.
Without understanding how student loan default works, getting your life and finances back on track can be challenging. This guide will cover everything you need to know so you can get in control of your debt and live your life to the fullest.
Defaulting on student loans, explained
Student loan default occurs when you don’t make payments per your student loan terms (also known as a promissory note). Unfortunately, student loan default can’t be discharged in most cases, so it’s crucial to understand what default means and how to get out of it.
A student loan enters default after a borrower misses a certain number of payments. Federal and private student loans each have different timelines before going into default.
- Federal student loans enter default after payments are 270 days, or 9 months, past due.
- Private student loans can enter default as soon as payments become 120 days, or 4 months, past due. However, the student loan’s promissory note may have different parameters about when the loan enters default. The timeline for defaulting on private loans varies by lender.
What happens if I default on student loans? If you default on student loans, lenders will report the defaulted loans to the 3 credit bureaus. The entire loan amount may become due and sent to a collection agency, where it will accrue additional costs.
If federal student loans are left unattended, lenders may garnish wages, tax returns, and Social Security payments in their attempt to collect the debt.
Student Loans: Default vs. Delinquency
Default and delinquency represent 2 different stages for borrowers that have missed their student loan payments.
Delinquency occurs when a borrower is late making their monthly payments. Default happens once a borrower has been delinquent for an extended period of time (as defined in the promissory note).
When a borrower has a missed payment, the lender will issue a warning and charge a late fee to the account. Fees will continue to accrue until the past due amount is repaid or other arrangements are made, such as deferment or forbearance.
During delinquency, the lender will notify you that you’ve missed your student loan payment and charge you late fees. Delinquent payments will be reported to the credit bureaus 30 days after the due date. They will stay on your credit history for 7 years.
If a student loan continues to be delinquent for an extended period, the lender will deem the loan as no longer meeting the conditions agreed upon in the promissory note. At that point, the loan will enter default.
Can you refinance student loans if they are in collections? Refinancing is typically not an option for student loans in default or in collections. Most lenders are unwilling to refinance debt with a poor payment history — even with a cosigner. However, once you get out of default and rebuild your credit score with several on-time payments, you may be able to refinance at that point.
What can happen if you default?
When you default on a student loan, the federal government can use many tools to collect the debt. Those tools will affect more than just your income. They have the power to affect your career, education, and ability to buy a house.
What are the consequences of defaulting on a student loan? The consequences of defaulting on a student loan may include:
- Lost income. To collect on defaulted federal student loans, the loan holder can garnish your wages, withhold your tax refunds and other government payments, like Social Security Benefits. Private lenders can’t take your tax refunds or Social Security income. They can be granted wage garnishment through a court order if they win a judgment against you. Private lenders can also access your bank accounts if granted through the courts.
- More money owed. Even though a loan may be in default, it will still accrue interest and late fees, thus increasing the loan amount. Additionally, collection fees are charged for the collection process of a defaulted loan. Collection costs can be as much as 25% of the loan balance.
- Career jeopardy. Speaking of jobs, defaulting on student loans can put your career at risk. Laws vary from state to state, but your state may revoke your professional license if you default on a student loan. Some states’ provisions apply to certain professions such as attorneys, teachers, health care professionals, financial professionals, and state officers. Some vocations impose a fine for members who default on their student loans.
- Educational delays. If you’ve defaulted on student loans, you can’t take out additional student loans or receive other federal student aid to return to school. Whether to finish a degree or attend graduate school, you won’t be able to obtain financial aid. Additionally, your school can withhold your college transcripts and your diploma until your student loans are repaid.
- Difficulty purchasing a home. Homebuyers who have defaulted on federal student loans lose eligibility to apply for an FHA mortgage loan because they’ll be reported to CAIVRS. Losing out on an FHA loan means having to apply for conventional mortgages that require larger down payments.
Unfortunately, there are many negative impacts that a student loan default can bring. That’s why it’s essential to address the situation as soon as possible.
Does defaulting on student loans affect credit? Yes, defaulting on student loans affects your credit. The late payments will negatively impact your credit score, causing higher loan rates and marring your credit report for years.
Those with poor credit scores have difficulty securing new loans and credit cards, competitive insurance premiums, and even certain jobs.
What is a student loan default rate? The student loan default rate is the percentage of borrowers who have defaulted on their loan in a cohort. Recent statistics show that as of 2020, the national 3-year default rate has decreased from 10.1% to 9.7%.
How do I know if my student loans are in default?
If you aren’t sure whether your student loans are in default or not, the best solution is to contact your student loan servicer. The loan servicer will be able to provide you with all of the information about your loan’s status, outstanding balance, repayment plan, and repayment options.
If you don’t know who your student loan servicer is, you have 2 primary options:
- Get a copy of your credit report, or
- Access your My Federal Student Aid account.
Your credit report will list all of your student loan debt. Any negative information about your student loans, like if they’re in default, will be listed in the negative information section. To get a copy of your credit report for free, go to annualcreditreport.com.
Every federal student loan borrower is given an account at the US government’s student aid website. Using your FSA ID at studentaid.gov, you can create an account and access your entire federal student loan portfolio.
From there, you can see if your student loans are in default. You can also get information about your loan servicer.
One other option is to create a MyEdDebt account. That site shows you all of your defaulted federal student loans owed to the U.S. Department of Education.
How to get out of default
The U.S. Department of Education lays out 4 options in which borrowers can get out of federal student loan default:
Each method can prevent and stop the consequences of default if you contact your loan servicer quickly. Depending on your current financial situation and intended outcome, some options may be more suitable for you.
How do I get out of default on student loans? To get out of default on student loans, you can repay them in full, take advantage of a student loan rehabilitation program, or consolidate your loans.
Option 1: Repayment
Repayment is the option that provides the immediate and complete resolution to your student loan default is repayment. However, since the entire balance and interest are due in full once the loan enters default, full loan repayment isn’t feasible for most people.
Option 2: Rehabilitation
Student loan rehabilitation may be the best option for most borrowers.
While private student loan lenders aren’t required to provide loan rehabilitation opportunities, all federal student loans allow defaulted borrowers a chance to rehabilitate their loans. However, this opportunity to rehabilitate will only be provided once.
Here’s how to start the loan rehabilitation process.
First, you’ll need to contact your loan servicer.
You can find your loan server’s contact information if you log into your studentaid.gov account. Once there, find the option that says “View loan servicer details.”
Next, you and your loan servicer can discuss the appropriate rehabilitation plan for your circumstance.
You can rehabilitate loans made under the William D. Ford Federal Direct Loan Program (Direct Loan) and Federal Family Education Loan Program (FFEL) loans by making 9 payments during a period of 10 consecutive months.
Your monthly payment amount will be 15% of your discretionary income, or a lower amount (if approved in advance based on the paperwork you provide to the loan servicer).
Loan rehabilitation will prevent further collection measures like wage garnishment and Treasury collections. Additionally, you regain the benefits you were eligible for, like deferment, forbearance, and student loan forgiveness programs, like the Public Service Loan Forgiveness Program. Finally, you’ll be able to receive further student aid.
How do I get a defaulted student loan off my credit report? You can only get a defaulted student loan off your credit report only through student loan rehabilitation. The rehab process will remove the default status. However, the late payments that led to the default will remain on your credit report for 7 years (or until the loan is repaid in full, in the case of Federal Perkins Loans).
Option 3: Student Loan Consolidation
Another quick way to get out of default is to consolidate your federal student loans into a Direct Consolidation Loan. The primary benefit of consolidation is that it can get your defaulted student loans back in good standing within just 2-3 months (versus 9-10 months for rehabilitation).
To qualify for a consolidation loan, you must either:
- Make 3 consecutive, on-time monthly payments on the defaulted loan, or
- Agree to repay the new consolidation loan under an income-driven repayment plan.
While a consolidation loan won’t remove a default from your credit report, it will reinstate your benefits. Consolidation may be a good option if you plan on returning to school and need access to federal student aid.
How to consolidate defaulted student loans
- Step 1: Log in to studentaid.gov. You’ll need a Federal Student Aid (FSA) ID to log in. Once inside, click “Manage Loans” and then “Consolidate My Loans”.
- Step 2: Choose the loans to consolidate. If a loan in default is already consolidated, you can reconsolidate if you include one other eligible loan in the consolidation or if it is an FFEL Consolidation Loan. The interest rate for the new loan will be a fixed rate based on the weighted average of the interest rate of the loans included in the application.
- Step 3: Choose a repayment plan. To consolidate your loans out of default, you’ll need to choose one of the income-based student loan repayment plans. Borrowers with Parent PLUS Loans will need to choose the Income-Contingent Repayment Plan (ICR).
- Step 4: Read the disclosures. Check your contact information, loans included in the application, and review the terms in the Master Promissory Note before signing.
- Step 5: Review the Loan Summary Statement. A few weeks after you apply, the loan servicer will send you a statement showing the details of your new Direct Consolidation Loan. Check the letter to see your new loan balance, interest rate, and monthly payment amount.
Option 4: Settlement
If your loans are in default — or dangerously close to it — you may have the option to settle. (Settlement is typically not available for loans in good standing.)
For federal loans, reaching a settlement will require contacting the collection agency about settlement options after defaulting. If you cannot pay the loan in full, they may bring up a compromise amount.
This compromise amount is the government’s settlement offer, which you may be able to negotiate down slightly.
Generally, private loans will consider a settlement after 6 missed payments. In order to pursue a private loan settlement, you will need to know who holds your loan, how much you could make as a lump payment, and how much you could afford to pay each month.
Once the private loan goes to the party that ultimately controls it, you can begin negotiating for a settlement. Federal student loans are generally willing to accept about 85-90% of the balance less collection charges. Private loans will typically settle for anywhere between 40-75% of the balance.
Settlement can be a fairly complex option for those in student loan default, and it’s often best to get legal advice before pursuing it.
Only in Special Circumstances: Bankruptcy
In rare cases, student loans may be discharged in bankruptcy. A separate action called an “adversary proceeding” must be filed requesting the bankruptcy court determine that repayment of the student loan would create an undue hardship on you and your dependents.
You must file a Chapter 7 or Chapter 13 bankruptcy to do so, and you must prove repayment would impose a financial hardship. Additionally, your lenders may be present to challenge your request.
It’s slightly easier to discharge private student loans than federal, in my experience. Still, bankruptcy for student loans is a significant challenge that I wouldn’t recommend trying without a student loan lawyer.
Consequences of ignoring student loans in default
What happens if you never pay your student loans? If you never pay your student loans, you could lose your professional license, wages, or tax refund. You will also owe even more money as interest accrues. The government’s efforts to collect defaulted student loans never end.
The fact is, not paying your student loans can have lasting damaging effects on many parts of your life. In more extreme cases, wage garnishments, court summons, and even arrest warrants have been used to track down defaulted borrowers who have skipped out on their student loans.
What happens to my student loans if I die? What happens to student loans if you die depends on the type of loan you have at the time of your passing. Federal student loans are discharged upon a borrower’s death.
Unfortunately, private student loans don’t have any obligation to cancel student loans in the case of a borrower’s death. Instead, the student loans may be passed on to the estate, and assets, investments, and bank accounts will be used to offset the student loan balance.
Need help with your loans? Let’s talk.
If the process for getting out of default sounds overwhelming, I’m here to help. For years, I’ve worked with people just like you with their federal and private student loans.
Schedule a free 10-minute call with me today. We’ll work together to develop a plan that fits your current financial situation and sets you up to meet your future goals.
Whether you have defaulted on federal or private student loans, we’ll get you back on track.