If you’ve missed student loan payments and are in default, you know how horrible it is. Your credit score may be wrecked. Your loan servicer can garnish your wages. You may even be dealing with collection agencies.
There’s no escaping the negative ramifications for not paying back your student loans – even if you switch banks.
It’s easy to feel overwhelmed and defeated if you’re in default. Yet, you’re not alone. Student loan debt has become a national epidemic. According to the U.S. Department of Education, over 530,000 borrowers entered into default between October 2014 and September 2017.
If you’re in student loan default, here’s what you need to know to get back on track and improve your finances.
What is student loan default?
Student loan default is an official loan status that occurs when you miss a certain amount of payments. According to Federal Student Aid, your federal loans are in default once you miss your scheduled loan payments for 270 days or more. With private student loans, you’re in default as soon as you miss three months’ worth of payments.
Entering into default is a serious problem. Take a look at what can happen:
- Lenders can garnish your wages, making it difficult to make ends meet.
- The default will stay on your credit report for up to seven years. And, with a damaged credit report, you may have trouble getting approved for a car loan or a mortgage.
- Late fees and interest will accrue, causing your loan balance to balloon.
- Your professional license could be suspended, hurting your chances of finding work.
Three ways to end student loan default
If you have federal or private student loans in default, you have three options:
1. Student loan rehabilitation
If you have federal student loans, one option to consider is student loan rehabilitation. With this approach, you work with your loan servicer to come up with a written agreement where you pledge to make nine voluntary and affordable monthly payments during a period of 10 consecutive months.
Loan rehabilitation has several benefits. After completing the nine payments:
- Your loans will no longer be in default.
- The loan servicer will remove the record of default from your credit report.
- Your loan holder will no longer garnish your wages or seize your tax refund.
- You’ll regain eligibility for benefits like loan deferment or forbearance and access to income-driven repayment plans.
- You’ll be able to qualify for additional federal student aid.
Your payment is determined by your loan servicer, but it will be equal to 15 percent of your discretionary annual income, divided by 12. Your discretionary income is the amount of your adjusted gross income that exceeds 150 percent of the poverty guideline for your state and family size. Under a loan rehabilitation agreement, your payment could be substantially lower than it was under a standard repayment plan.
For example, let’s say you’re single, live in one of the 48 contiguous states, and make $30,000 per year. According to the U.S. Department of Health and Human Services, the federal poverty guideline for you is $12,490.
Your discretionary income is calculated by subtracting 150 percent of the poverty guideline — $18,735 — from your income. You’d subtract $18,735 from your income of $30,000 to get $11,265.
Your payment under a loan rehabilitation agreement would be 15 percent of your annual discretionary income, divided by 12. To calculate your payment, you’d take 15 percent of $11,265, which is $1,689.75. Divide that number by 12 to get your monthly payment: $140.81.
If you can’t afford the payment because of extenuating circumstances — such as higher than usual medical bills or housing expenses — you may be able to negotiate a lower payment. You’ll have to provide the loan servicer with documentation about your income and expenses. They’ll use that information to calculate a new payment after subtracting your necessary expenses from your income.
If you decide that loan rehabilitation is right for you, contact your loan servicer directly to start the process.
2. Federal loan consolidation
Another option to get out of loan default is federal loan consolidation. With this strategy, you consolidate your defaulted federal loans with a Direct Consolidation Loan.
To qualify for loan consolidation for defaulted loans, you must agree to repay the new loan under an income-driven repayment plan and make three consecutive, voluntary, on-time monthly payments before you can consolidate.
Once you consolidate your loan, your loan is no longer considered to be in default. You’ll regain eligibility for federal benefits like forbearance, deferment, and additional student aid. However, consolidating your debt doesn’t remove the record of the default from your credit report.
While consolidation can be an effective strategy, it won’t work for everyone. If your defaulted loan is being collected through wage garnishment or in accordance with a court order, you can’t consolidate your loans until the wage garnishment order or the judgment is lifted.
3. Student loan refinancing
If you have private student loans, you can’t qualify for loan rehabilitation or loan consolidation. Instead, your options are limited.
In most cases, the only way to get out of default is to pay off your loan in full. But if you’re in default, you likely don’t have enough money in the bank to do that. This doesn’t mean you’re out of luck. It just means you may have to consider student loan refinancing.
With student loan refinancing, you work with a private lender to take out a loan for the amount of your current debt, including the loans in default. You use the new loan to pay off the old ones, instantly ending the default. If your loans were in collections, all collections activity will end, and the lender will no longer be able to garnish your wages.
However, there are some downsides to consider. Since your loans were in default, your credit score likely went down. This means you may not qualify for a refinancing loan on your own.
Yet, you may get approved for a loan if you have a co-signer — a friend or relative with excellent credit and a steady income who signs the loan application with you. Because having a co-signer lessens the risk to the lender, you’re more likely to be approved. Keep in mind that if you fall behind on your payments, the co-signer is responsible for making them.
Repaying your student loans
If your student loans are in default, your situation is serious.
However, there are strategies you can use to get out of default and get your finances back on track. By following these tips, you can end the default and start saving money.