At the end of 2008, more than $39 billion in federal student loans were in default status. Among borrowers who started repaying their loans in that year alone, about 14% percent have already defaulted – that is more than 450,000 former students, according to the Department of Education.
A student loan typically reaches default status after 270 days of no payments. The loan then becomes due in full upon lender’s request. New collection costs and late fees are typically added to the total balance, and the total amount owed becomes drastically higher than before. All these costs may be reduced or eliminated through negotiating with the lender or legal action.
There are plenty of other negative consequences resulting from a default on a loan. For instance – students who may wish to return to school will not qualify for federal aid in the United States until they make payment arrangements with the lender, or the loan is in good standing – which may sometimes happen only after a year of on-time payments. Student borrowers who are concerned about repaying their debt should seek expert advice. Unfortunately, at the current time, there are limited options available other than loan payment in full or loan rehabilitation. The Bankruptcy Abuse Prevention and Consumer Protection Act make student loan discharge through bankruptcy difficult, but not impossible. It is critical that you never ignore a loan in default – as you read in the next section, unresolved defaulted loans may be detrimental to your financial status, and may impact many important life decisions, such as going back to school, for instance.
Tax Refund Offsets
The IRS has the power to intercept and retain any income tax refund you may be entitled to until your student loans are paid in full. This is one of the most popular methods of collecting on defaulted loans, and the Department of Education annually collects hundreds of millions of dollars by retaining income tax refunds. In some cases, student borrowers may challenge a tax refund offset, however, they may need attorney assistance. You can find a legal expert near you using a legal directory.
The government may also garnish wages as a way to recover money owed on a defaulted student loan. The United States Department of Education or a Student Loan Guarantor can legally garnish 15% of a defaulted borrower’s wages; however, it cannot take more than the equivalent of 30 times the current federal minimum wage. The loan holder does not have to sue the borrower first. The borrower may object to the garnishment, but only under very specific circumstances, such as if his or her weekly gross income is less than equivalent to 30 hours at the federal minimum wage (currently $7.25/hr x 30 hrs = $217.50).
Of course, the best way to avoid wage garnishment is to contact the holder of your loan and negotiate a repayment schedule that best suits your financial situation.
Defaulting on student loans can also end in a lawsuit. The government and private lenders can sue the defaulted student borrower in order to collect on loans. There is no time limit on suing to collect on federal student loans, and the borrower can be sued indefinitely. Private student loans, in most cases, are subject to statute of limitations laws depending on the state.
Getting Out of Default
There are three main ways to resolve student loans which are in default status. However, the majority of these solutions only work for federal loans. Although we do list some options for private school loans, they typically are the most problematic ones, as private lenders are usually reluctant to work with borrowers who are not in good standing.
Loan rehabilitation is a federally mandated program that is designed to help student borrowers to get out of debt and bring their loan back to good standing. Student loan rehabilitation may reverse many negative consequences of defaulting on a student loan, and participation is one of the few rights granted to defaulted federal education loan borrowers.
Once in the rehabilitation program, a borrower must do a number of things. First, he or she must agree on a reasonable and affordable payment plan and make at least 9 qualifying, on-time student loan payments. If any payments are missed, the payment schedule re-starts, and the borrower must meet the 9-payment requirement again. Once borrowers complete this agreement, the guarantor (i.e. Dept. of Education) transfers the loan to a lender and servicer. The important thing to keep in mind here is that even though you are repaying your loans, any outstanding collection costs may still be added to the principal balance, and whatever payments were collected from you through wage garnishment or legal action do not count toward loan rehabilitation. Once you have made 9 on-time, qualifying payments, and the loan has been transferred, it is then officially out of default.
Once the loan rehabilitation is complete, student borrowers may be eligible to receive financial aid once again. Also, since the loan is no longer in default status, wage garnishment and the withholding of tax refunds will stop as well. Student borrowers will be able to apply for deferment and forbearance, as long as those options have not already been exhausted before the default. And finally, the outstanding balance is not due in full, since the borrower is now making regular payments on the loan based on the terms reached during loan rehabilitation.
Loan consolidation is a great way to get your loan out of the default status. Loan consolidation allows student borrowers to combine one or more of their federal loans into one combined loan with a single monthly payment and a fixed interest rate.
A federal student loan that is in default may be included in the consolidation process only after you’ve made the necessary arrangements with the lender and have made several on-time payments (three consecutive payments is typically adequate). For help or questions click loan consolidation.
Federal loan consolidation does have certain limitations – for instance, you cannot include private loans in the consolidation process. Also – spouses are unable to consolidate their loans into a single consolidated loan, and, moreover, borrowers who are in default must meet certain requirements before they are allowed to consolidate.
Of course, the simplest option for getting out of default, as unreachable as it is to most borrowers, is to repay the loan amount in full. Contact your lender directly to get information about how to repay the loan and where to send the payment.