Sense & Centsibility Blog

What You Need to Know About Defaulted Student Loans

student loans

Student loan default rates are the rise. According to a study done by the Federal Reserve Bank of New York, of the 37 million borrowers who have outstanding student loan balances, 14.4% have at least one past due student loan account (as of third quarter, 2011). That’s about 5.4 million borrowers! Nearly one in 10 borrowers who started repayment in 2009 defaulted within two years – and that’s just for those starting repayment in 2009.

Defaulting on your student loans can have massively negative consequences: the federal government has powers to recapture your tax refunds, garnish your income without taking you to court, and can even garnish certain amounts and types of Social Security income. Not to mention there is no time limit on how long they can try to collect on your defaulted loans. Collectors for defaulted private student loans do not have the same collection powers, but defaulting on both types of loans will have a negative impact on your credit and make it nearly impossible to borrow for a house or car for many years to come. Regardless of your situation or student loan status, don’t wait - it’s better to take action now.

The scam

Enter the Student Loan Relief companies…”to the rescue”! These guys claim they can fix everything for you – stop wage garnishments, tax recaptures, and collection calls; lower your payments; fix your credit; consolidate your loans – you name it, they claim they can get it done. And your money back guaranteed! What? You thought help would be free? You don’t have $600 to pay a company to help you with your defaulted loans? If you did, you would give it to your loan servicer? Good - because that’s exactly what you should do…really folks. If you are approached by one of these companies, run. Hang up the phone, step away from the computer, don’t sign that contract and DON’T GIVE THEM YOUR MONEY. Why not? Because they can’t do anything for you that you can’t do for yourself – for free – with a little research, determination, and persistence.

Avoid defaulting in the first place

The best way to get out of default is to not get there in the first place. It takes 9 months of not making payments to default on your federal student loans (less for private loans, but we’ll get to that in a minute). If you can’t make your payment on your federal student loans, call your servicer immediately. You can request a deferment or forbearance on your federal student loans. These are temporary ways to stop your payments – usually around 6 months to a year, but possibly longer under certain circumstances. If you put your loans in forbearance, they will accrue interest whether they are subsidized or unsubsidized. This means you will owe more at the end of your forbearance. If you put your loans in deferment, the interest on unsubsidized loans only will accrue – the federal government will cover the interest on your subsidized loans.

One important note on deferments and forbearances: these are not good strategies for putting off repaying your loans because you can’t afford it. I repeat: because interest accrues they will only get bigger over time. If you are struggling to make your payments, but think you can afford to pay something, contact your servicer and ask about a graduated payment plan, Income Based Repayment plan, Income Contingent Repayment plan, or an extended loan term (only for those over $30,000). Once again, with most of these plans you may end up accruing more interest, but it is better than allowing your loans to default.

Dealing with defaulted federal student loans

student loans

If it is too late for you and you have already defaulted on your loans, don’t give up. There is hope! You have two options for getting your federal loans out of default. The first way is to work out an affordable repayment plan with the collection agency trying to collect on your loans. (It is important to note that you have the right to a rehabilitation payment that is affordable for your income level and financial situation. If a collector tells you the company can’t take less than a certain amount, they are violating your rights.) Once you have worked out this repayment plan and you make 9 out of 10 payments on time, your loan will be rehabilitated. Any record of your loan being in default will be removed from your credit (but not necessarily late payments). This is the advantage of a rehabilitation program.

The other way to get your federal loans out of default is through the Direct Loan Consolidation program. Consolidating your loans will get you back into repayment more quickly, but your defaulted status will not be removed from your credit report. You will be required to select an Income Contingent or Income Based repayment plan and will likely need to submit your income information along with your application for consolidation. This option does not require payments before being able to consolidate your defaulted loans (despite what any collection agent may say – remember they work on commission: the more they can get you to pay, the more they make).

There are four important things to know about using these methods to get your loans out of default:

1. one strike and you are out:  if you default on a loan that has been rehabilitated or consolidated after default you will have no second chance to get them out of default again;

2. collection fees of up to 18.5% of your loan will be added to the rehabilitated loan or consolidated loan;

3. if you have more than one loan that defaulted you must rehabilitate each loan individually; and 4. lenders cannot come after you once the consolidation or rehabilitation process is complete, as long as you stay current.

You can learn more about the process and pros and cons of rehabilitation vs. consolidation at the Student Loan Borrower Assistance website. If you have tried everything you can and still can’t get a positive resolution, enlist the help of the student loan ombudsman’s office.

What about defaulted private student loans?

Private student loan collectors do not have the same collection powers as those collecting on defaulted federal student loans. These debts have a time limit to how long the collector has to sue you to collect the debts (time limits vary state-by-state). If they sue you and they obtain a judgment, it can be renewed again and again, which basically gives them an unlimited time to collect. If they obtain a judgment they can garnish your wages. Certain types of property and income may be protected, or exempt, from garnishment. If you are being sued you may want to seek legal counsel. Whether the collector is collecting for a federal student loan or a private loan, you have rights under the Fair Debt Collection Practices Act.

Unlike federal loans, there are few options for dealing with defaulted student loans. Neither federal loans nor private loans can be discharged through bankruptcy – at least not easily. Your best bet is to try to work out a repayment plan with the collector, or save up your money and offer a settlement on less than what you originally owed. If you are unable to come to a reasonable work-out with a private student loan collector, you may want to try filing a complaint with the new Consumer Finance Protection Bureau.

Take action

If you have defaulted on your student loans, whether federal or private, don’t give up hope. It can be overwhelming trying to figure out which options are best for you. And if you are like others who have defaulted on their student loans you may also be dealing with credit card debt, medical bills, or other collection accounts.

Use the resources above to arm yourself with information and click here for more information on student loans and bankruptcy. Create a budget to figure out what type of payment you can afford to put towards your loans. This will give you the confidence to negotiate with collectors. Enlist friends, family, or professionals to help you. But DON’T GET SCAMMED! There is free help out there. Call LSS Financial Counseling for a free, confidential appointment at 1-888-577-2227 or START ONLINE COUNSELING NOW.

Author Shannon Doyle is a Certified Financial Counselor with LSS who specializes in budget/debt counseling and student loans.