Why Borrowers of Federal Student Loans Should Not Default, and How to Avoid Default.
This article explains the results of not paying a student loan, and options for avoiding a default on federal student loan. If you have not made payments but can afford to now, rehabilitation will repair the damage to your credit report. If you cannot afford your federal student loan payments, contact your loan servicer because you may qualify for a deferment, forbearance, or consolidation.
Consequences of Default on a Federal Student Loan
The Dept. of Education classifies a federal student loan in default status if the borrower makes no payments for 270 days. (Private student loans are delinquent after 120 days.) A consequence of a defaulted student loan is loss of eligibility for future student loans or any type of state or federal student aid. The default is reported to all national credit reporting agencies (commonly called credit bureaus), which generally eliminates the option of private loans, which are based on credit score. Another consequence of a default is possible administrative wage garnishment.
While a federally insured student loan is in default, the Dept. of Education will not allow the borrower to obtain any more government backed loans. Luckily, the same regulations also state that the borrower need not pay off the entire balance of a defaulted loan to become eligible to borrow again. The Dept. of Education requires that student loan servicers, the companies that lend money and/or manage students loans under an agreement with the Dept. of Education, provide borrowers a way to bring defaulted loan current, a process called rehabilitation.
There is no statute of limitations that prevents the Dept. of Education from collecting a federal student loan debt.
Rehabilitating a defaulted loans will not only make the borrower eligible for new student loans, it will also clear the delinquencies these accounts are showing on your credit reports, meaning that the accounts should appear as if you never defaulted on the loans.
Rehabilitating a delinquent loan is a relatively easy and straightforward process. First, contact your lender or servicer to express your desire to repay and rehabilitate your defaulted loan. Second, once you and your lender agree on a repayment plan, you need to make sure you make all of your payments on time. Late or missed payments will jeopardize the rehabilitation plan. Third, after you make six timely payments on the plan, you will again be eligible to obtain federally backed student loans. Finally, after you make 12 payments on time, the lender will finalize the loan rehabilitation by reporting the account as current to the credit bureaus and removing the past delinquencies from your credit reports.
According to the Dept. of Education, a deferment is a postponement of payment on a loan, during which interest does not accrue if the loan is subsidized. The following borrowers qualify for deferment:
- Enroll at least half time in an eligible postsecondary school or studying full-time in a graduate fellowship program or an approved disability rehabilitation program.
- Are unemployed or meet the Dept. of Education rules for economic hardship (limited to three years).
You may also be eligible for a deferment based on qualifying active duty service in the U.S. military. If you return to school and your loan servicer receives enrollment information that shows you enroll at least half time, it will put your loans into deferment and notify you automatically. You have the option of cancelling the deferment and continuing to make payments on your loan.
If you are in default on your loan, you are not eligible for a deferment or forbearance.
If you cannot make your scheduled loan payments, but do not qualify for a deferment, the Dept. of Education may give you a forbearance. A forbearance allows the borrower to stop making payments on a loan temporarily, make smaller payments temporarily, or extend the time for making payments. Some common reasons for getting a forbearance are illness, financial hardship or serving in a medical or dental internship or residency.
Under certain circumstances, the Dept. of Education may grant a forbearance automatically, for instance, while processing a deferment, forbearance, cancellation, change in repayment plan, or consolidation, or if the borrower is involved in a military mobilization or a local or national emergency.
Federal Student Loan Consolidation
Federal student loans issued before July 1, 2006 have variable rates, which means the interest rate resets annually on June 30. Federal loans issued after that date have a fixed interest rate.
If the current interest rate on your federal loan is variable, consolidate the loan to lock in a fixed rate. Consolidating fixed rate loans also has advantages, including the ease of a single monthly payment. Many lenders also offer bonuses for consolidation such as a rate reduction of .25 to 1% after a number of on-time payments, and possibly an additional .25 to .50% rate reduction for automatic payments.
In addition to the potential rate reduction of up to 1.5%, most consolidation loans include choice of repayment plans. Repayment plans determine your payments by dividing the principal plus total interest by the life of the loan. The amount of the payment depends on the plan you choose:
- Standard repayment: Equal payments for the life of the loan, usually ten years, and minimum payments are $50.
- Extended repayment: Equal payments over a longer term (up to 25 years), which reduces monthly payments but increases the total interest expense. Must have more than $30,000 in outstanding FFEL Program or Direct Loans.
- Graduated repayment: Lower payments at first, when your income is lower. Payments increase every two years until the loan is paid off. Payment term is 10 years.
- Income Based Repayment: Income Based Repayment (IBR) is a new repayment plan for the major types of federal student loans. Under IBR, the required monthly payment is capped at an amount that is intended to be affordable based on income and family size. You are eligible for IBR if the monthly repayment amount under IBR will be less than the monthly amount calculated under a 10-year standard repayment plan.
- Income contingent repayment: For federal Direct Loans. Monthly payment amounts are reset each year based on your annual gross income as reported on your US tax return.
- Income-Sensitive Repayment Plan: For FFEL Loans. The monthly loan payment is based on your annual income. As your income increases or decreases, so do your payments. The maximum repayment period is 10 years.
Some lenders offer a two- to nine-month grace period following your graduation. The grace period may include interest subsidies. To ensure you receive all the subsidies, ask your consolidation lender to accept your paperwork in time to receive the best rate, but delay processing until your grace period is about to expire.
The Dept. of Education provides a list of resources available for consumers who have defaulted on their loans, available at the Addressing Your Defaulted Student Loan resource. See the Bills.com resource Student Loan in Default if you have already defaulted and need to rehabilitate your federal student loan.