Advice About Federal Student Loans in Default
- 5 min read
- Apply for a deferment first.
- If that fails, then apply for a forbearance.
- Apply before you stop paying your federal student loan.
How and Why Borrowers of Federal Student Loans Should Not Default, and How to Avoid Default.
This article outlines what happens when a federal student loan goes into default status, how borrowers can avoid default, and the steps borrowers can take to remove themselves from default status.
Federal Student Loan in Default Status
A federal student loan may be called a "federal loan," but the borrower makes monthly payments to a loan servicer, such as Sallie Mae, not directly to the federal government. Once a borrower stops paying a federal student loan, the loan servicer must exercise "due diligence" in attempting to collect the loan. The loan servicer must make repeated efforts to contact the borrower about repayment. If a loan servicer’s efforts are unsuccessful, place the loan in default status and to turn the loan over to a local state guaranty agency that administers the Federal Family Education Loan Program (FFELP).
The total outstanding balance of student loans was $1.03 trillion as of September 2013. The 90-day or more delinquency rate at that date was 12%. By comparison, the delinquency rate was 6% in 2003. (Source: Federal Reserve Bank of New York)
When a loan is assigned to a state guaranty agency or the Dept. of Education for collection, the following collections may occur:
- The Department of the Treasury may offset federal and state tax refunds and any other payments. This is called offset.
- The borrower may have to pay additional collection costs after the loan is assigned to a private collection agency.
- The borrower may be subject to administrative wage garnishment, which can total 15% of the borrower's disposable income.
- The Dept. of Education may file a lawsuit against the borrower.
- Credit reporting agencies may be notified, resulting in a derogatory entry on the borrower's credit report.
Once a loan is declared in default, the borrower may not receive deferments or forbearances, or any Title IV federal student aid if in default on any Title IV student loan. The rehabilitation period for Title IV federal student aid is six consecutive months of repayments.
Federal education loans are in default 270 days of non-payment. Private student loans default after 120 days.
How to Avoid Default on a Federal Student Loan
A federal student loan borrower can receive payment deferment or forbearance on current loans. A deferment allows the borrower to postpone payments. Subsidized loans, including Perkins Loans, will not accrue interest during the deferment. Unsubsidized loans will accrue interest on the loan during the deferment. FFEL borrowers should contact the lenders or agencies holding the loans to request a deferment. Perkins borrowers should contact the loan servicer or the school that issued the loan. Request a deferment before you go into default.
Forbearance allows the suspension of payments for a limited and specified period. It is an alternative to deferment when the borrower does not qualify for deferment. Interest charges accrue. According to the Dept. of Education, forbearance for a federal student loan can occur when the borrower:
- Cannot pay a federal student loan due to poor health or similar circumstances.
- Serves in a medical residency.
- Serves in a position under the National Community Service Trust Act of 1993.
- Is obligated to make payments on certain federal student loans equal to or greater than 20% of the borrower’s monthly gross income.
Deferments and forbearances are not automatic. Direct Loan borrowers should contact the Direct Loan Servicing Center to request either option. FFEL Loan borrowers should contact the lender or agency that holds the loan. Perkins borrowers should contact their loan servicer or the school that issued the loan.
Borrowers unable to afford to make payments toward a defaulted loan should complete and return a Statement of Financial Status (PDF) along with evidence of their current financial situation. This may include paycheck stubs, copies of billing statements, and expenses. The borrower should send the statement to the servicing agency or the collection agency servicing the account. The state guaranty agency will create a payment plan based on the borrower’s income and expenses.
In 2012, the average debt load for college graduates was $29,400 per student. About 7 out of 10 seniors carry student loan debt. (Source: College Access & Success Project on Student Debt)
See the Bills.com resource Student Loan Debt Relief to learn more about permanent student loan consolidation loans and other options.
Steps to Recover from a Federal Student Loan Default
The Dept. of Education refers to the recovery and repayment of a defaulted federal student loan as loan rehabilitation. Completing a loan rehabilitation will delete the default status at the credit reporting agencies. It will also cease tax refund garnishments, and make the borrower eligible for federal loans and grants. According to the Dept. of Education, these loans can be rehabilitated as follows:
"To rehabilitate a Direct Loan, you must make at least nine (9) full payments of an agreed amount within twenty (20) days of their monthly due dates over a ten (10) month period to the U.S. Department of Education (Department). Payments secured from you on an involuntary basis, such as through wage garnishment or litigation, cannot be counted toward your nine (9) payments. Once you have made the required payments, your loan(s) will be returned to the Direct Loan Servicing Center."
Federal Family Education Loan (FFEL)
"To rehabilitate a FFEL, you must make at least nine (9) full payments of an agreed amount within twenty (20) days of their monthly due dates over a ten (10) month period to the Department. Payments secured from you on an involuntary basis, such as through wage garnishment or litigation, cannot be counted toward your nine (9) payments. Once you have made the required payments, your loan(s) may be purchased by an eligible lending institution."
"To rehabilitate a Perkins Loan, you must make nine (9) on-time, monthly payments of an agreed amount to the Department. Payments secured from you on an involuntary basis, such as through wage garnishment or litigation, cannot be counted toward your nine (9) payments. Once you have made the required payments, your loan(s) will continue to be serviced by the Department until the balance owed is paid in full."
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.
If the current policy and programs where available 13 years ago I would never have defaulted in the first place. I've looked at the IBR and I'm now in a position to start repaying and plan to do so.
I'm in a position to co-purchase a home with a conventional mortgage. I would like to know what type of liability I would be bringing to the purchase. Here are a few questions for you: 1. Will the DOE pursue a lien against my half of the home? 2. If the mortgage is paid exclusively by the co-signer (non-spouse) will the DOE ever become aware of my interest in the property? 3. Would this debt cause a problem for a conventional mortgage?
Please advise me of any issues you think pertinent.
My advice? Talk to a loan officer or broker about the student loan issue, and how exactly the lender's underwriting department will view the loan. Second, if the reaction is negative, then rehabilitate the loan.