Q: Is it better to consolidate or rehabilitate a defaulted student loan?

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Stanley tate

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When you’re in student loan default and you’re deciding between student loan rehabilitation vs consolidation for federal student loans, the right choice often depends on your goals. 

If you want to get out of default ASAP, then consolidating federal loans out of default is better. But if you want to keep your student loan debt low, then rehabilitation is better because it waives collection fees.

What are the key differences between consolidation and rehabilitation for student loans?

The key differences between consolidation and the loan rehabilitation program for federal student loans are speed and cost.

Consolidation is 3x faster

Applying for a Direct Consolidation loan brings a defaulted student loans back into good standing quickly in 2 to 3 months. Completing the rehab program takes 3x as long.

The reason why it takes so much longer is that the program requires you make 9 monthly payments.

Consolidation doesn’t require you make monthly payments on your federal student loans before the consolidation application is processed.

Instead, to consolidate a defaulted federal student loan you need only agree to repay the consolidation loan under an income-based repayment plan.

Because of the difference in speed, if you’re pursuing loan forgiveness under the Public Service Loan Forgiveness Program, consolidation is the better choice. You’ll start earning credit towards student loan forgiveness 3x faster.

Rehabilitation is often cheaper

After you complete the loan rehab program, the US Department of Education waives collection fees added to your loan debt. Contact the loan servicer for those loans to see if they’re willing to waive the collection fees.

They do not waive fees for consolidation loans. Instead, when you consolidate, the Department of Education adds the collection fees to your new principal loan debt. As a result, you’ll end up owing a lot more than you originally borrowed.

So if your overall student loan debt is low, and you have a realistic shot at paying it off, rehabilitation makes more sense.

Collection fee waiver limits

The collection fee waiver applies only to federal loans owned by the Department of Education. If your defaulted loan is a FFEL or Federal Perkins Loan, that loan may be owned by an entity other than the Department of Education. You'll need to contact the loan holder to learn if they're willing to waive collection fees.

About private student loan rehabilitation

There’s no private student loan rehabilitation program

On top of that, it's hard to find a lender willing to refinance delinquent private loans. That makes sense. If you have late payments on those loans, what guarantee do private lenders have you won't have late payments on the new loan?

Which is better for credit score: consolidation or rehabilitation?

Based on my experience, both consolidation and rehabilitation have about the same impact on student loan borrowers’ credit scores.

Neither one removes late payments from your credit report. Those late payments will remain a part of your credit history.

The only difference between the two is that the rehab program will remove the default status from your credit report. Loan consolidation pays off the loans. The default status remains a part of your credit history.

Exactly how much the default status means to your credit score is unclear. Because of that, it’s my belief that the potential impact on your credit score shouldn’t influence your decision whether to consolidate or rehabilitate.

How long is student loan rehabilitation?

The student loan rehabilitation program lasts about 9 to 10 months. Occasionally, the process can take longer. I’ve found the process can be slowed by failing to timely process the rehabilitation income and expense form or to approve the rehabilitation agreement letter.

To ensure your process isn’t slowed, make sure you follow up with the collection agency to confirm they’ve received your paperwork and that your paperwork has been approved.

How long does a student loan consolidation take?

Loan consolidation typically takes about 2 to 3 months to complete.

Over the years, I’ve found that of all the loan servicers, Great Lakes usually completes the process faster than do the other servicers. Navient and FedLoan Servicing are among the slowest.

Does my anecdotal evidence mean you should choose Great Lakes as your loan servicer? No. After consolidation, you’ll still need to work with your servicer to set up loan payments and to request a deferment or forbearance. Because of that, you should choose a loan servicer based on their overall customer service reputation.

Does consolidation stop a student loan tax offset?

Consolidation will stop a student loan tax offset only after the consolidation completes. Wait until the consolidation completes before you file your tax return. Contact your servicer to confirm the state of your consolidation loan.

Click here to learn How to Stop a Tax Refund Offset for Student Loans

Does rehabilitation stop a student loan tax offset?

The loan rehabilitation program will stop a student loan tax offset but only after you complete the program. If I was expected to get back a tax refund, I’d wait until not only I completed the loan program, but my loans were transferred to a servicer and I entered into a repayment plan.

How to apply for a consolidation loan?

You can apply for a consolidation loan for free at the Federal Student Aid website, studentaid.gov.

You're eligible to consolidate so long as you're not under a wage garnishment for the defaulted loan you're seeking to consolidate.

How to apply for the loan rehabilitation program?

You apply for loan rehabilitation by contacting the collection agency handling your federal student loans. To find out who that is, contact the Department of Education's Default Resolution Group at 800-621-3115.

You're eligible for the program if this is your first time completing the program for that defaulted student debt. Rehabilitation is a one-time opportunity. You can't rehabilitate the same loan twice.

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