How to Get Out of Default on a Student Loan
Defaulting on a student loan has serious financial and legal consequences. But a loan default is not the end of the world — or the end of your credit. There are several ways you can get out of default, repay your debts, and repair your credit rating. The process begins with confronting the problem and finding practical, manageable ways to solve it.
No matter how carefully you plan your life after college, circumstances can change. Many new graduates have trouble finding jobs. Some discover that they want to follow a different career path. Others have serious misfortunes or setbacks and suffer financially as a result. If you’ve let your loans go into default, you’re not alone. According to the U.S. Department of Education, student loan defaults are on the rise. In fiscal year 2010 and 2011:
- Students graduating from private for-profit schools defaulted at a rate of nearly 14 percent after two years and close to 22 percent after three years.
- Students graduating from public institutions defaulted at a rate of almost 10 percent after two years and 13 percent after three years.
- Students who graduated from private non-profit schools defaulted at a rate of just over 5 percent after two years and just over 8 percent after three years.
As the costs of higher education increase, so do the default rates on student loans. The sooner you confront the reality of student loan debt, the greater your chances of avoiding the serious consequences of default, such as added interest fees and penalties, garnished wages, and loss of eligibility for further loans. In some cases, you may even be sued for the full amount of the defaulted loan.
It doesn’t take long for a student loan to go into default. Federal student loans typically go into default after you fail to make a payment for nine months, or 270 days. Private student loans can go into default as soon as three months, or 90 days, after you stop making payments. For repayment information on your specific loans, consult your promissory note. The promissory note is the contract you signed when you agreed to repay the debt. If you don’t have access to this document, get in touch with your student loan provider.
Calling a lender or collection agency can be scary. A lot of graduates let their payments lapse simply because they feel frightened or overwhelmed by the idea of owing all that money. Don’t let fear stand in the way of getting out of default and repairing your credit. The professionals on the other end of the phone will most likely be glad to work with you. Remember that it’s always better to initiate contact with lenders or collection agencies than to wait for them to contact you.
If you contact the lending agency within 90 days after the 270- or 120-day default period, it’s possible that the agency hasn’t reported your loan as being in default. This means that you could start repaying the loan before your credit rating has been seriously harmed.
What Are My Options?
There are several options for repaying a defaulted student loan. Each strategy has its advantages and disadvantages. Your choice should be based on your financial resources, the status of your loans, and your plans for the future. With most repayment plans, you have only one chance to get out of default. If you stop making payments after making arrangements to pay off your debt, you could face severe financial consequences.
- Loan repayment. One option for getting out of default is to pay off the loan in full. The U.S. Department of Education and other lending agencies will accept reasonable and affordable monthly payments. Call your lender, or the agency that is contacting you about the default, to arrange a repayment. Loan repayment may be the best option if you are financially constrained and need to make payments that fit your budget. Be aware that if your loans have gone to a collection agency, the agency may not be as flexible about negotiating affordable payments.
- Loan consolidation. With a loan consolidation plan, federal student loans are combined in a single loan with one monthly payment. Direct Consolidation Loans are issued by the William D. Ford Direct Loan Program through the U.S. Department of Education. Consolidation can simplify the repayment process, and you may have as long as 30 years to pay your loan back. However, this means that you will end up paying more money in interest over the long-term. Consolidation is a good option if you want to qualify for other federal lending programs, such as a Federal Housing Association or Veterans Administration loan, or if you want to borrow more money to go back to school. Federal consolidation is available only for federal student loans — not for private loans. Private loans can be refinanced, though.
- Loan rehabilitation. If your priority is to repair your credit rating, loan rehabilitation is the best way to get out of default. With a rehabilitation plan, you must contact your lender or billing agency to negotiate a payment schedule that’s reasonable and affordable to you. After you make the required number of payments voluntarily (typically nine payments in 10 months), the loan will be considered in rehabilitation. At that time, the default status will be removed from your credit report, and you will be eligible for other federal lending programs. Wage garnishment will stop, and you will continue to receive your federal tax refunds. However, any late payments or payments that you failed to make before the loan default will stay on your credit report.
- Loan cancellation or discharge. In certain cases, student loans can be cancelled, discharged, or forgiven. These cases include closure of the school you were attending, death, total and permanent disability, falsification of your eligibility for a loan by the school, or an unpaid refund to the Department of Education by your school if you withdrew from the institution. In very rare cases, student loans can be forgiven in the case of a bankruptcy. Student loans may also be forgiven through participation in programs like Teacher Loan Forgiveness and Public Service Loan Forgiveness. With these programs, you commit to working in a high-need area for a certain amount of time in exchange for having your loan reduced.
- Make a budget, and stick to it. Learning how to budget your income will help you avoid financial surprises and delinquencies. Staying within the limits of your budget will help you meet your financial commitments and achieve your dreams.
- Build an emergency savings fund. Saving money for unexpected expenses like car repairs, medical bills, or emergency travel can help you avoid tapping into your credit cards. In addition to setting aside money for savings each month, consider selling personal items that you don’t need in order to create a financial cushion.
- Pay off current debts. According to statistics from CNN Money, college students graduated with an average of over $35,000 in debt in 2013. In addition to student loans, that amount included personal loans, credit cards, and money borrowed from family members. Paying off these debts will increase your financial freedom and help you avoid default in the future.
- Avoid acquiring new debt. Aside from keeping one credit card for emergencies or specific expenses, try to avoid personal debt. High-interest credit cards, in particular, can take a toll on your financial health. Before you purchase any new clothing, jewelry, equipment, or other personal items, give yourself 72 hours to think about whether you really need it.
- Pay all your bills on time. Every delinquent payment can take a toll on your credit rating. Paying your bills on time helps you establish yourself as a responsible lender.
- Learn about loan repayment and deferment options. In the future, you may decide that you want to go back to school to advance your education. If your defaulted loans have been rehabilitated, consolidated, or repaid, and your finances are in good standing, you can qualify for further loans. Before you borrow money, learn about your options for repaying or deferring your loan after you graduate. Today, there are many flexible programs for graduates who want to meet their commitments and avoid default.
When it comes to negotiating affordable repayment plans, lenders aren’t always fair or honest with their student borrowers. If you feel that you’re being treated unfairly by a lender or collection agency, you can file a complaint about your student loan with the Consumer Financial Protection Bureau. Your lender will be required to respond within 15 days of receiving your complaint. The U.S. Department of Education’s Federal Student Aid Ombudsman is another valuable resource if you find yourself in a dispute with a lender.
Earning a college degree is a great accomplishment. Unfortunately, that degree doesn’t guarantee immediate financial security. According to The Atlantic, over half of college graduates (53 percent) who earned bachelor’s degrees in 2011 were unemployed or held low-paying jobs that didn’t require a degree. Building a successful career and a stable financial foundation can take years. Meanwhile, it’s easy to fall into the trap of relying on credit cards to cover basic expenses you advance in your profession. Many graduates default on their student loans because they are also burdened with personal debts, auto loans, and other financial commitments.
The best way to repair your credit after a student loan default is to negotiate a consolidation or repayment plan and make your payments on time. With loan rehabilitation, the default will be deleted from your credit report. But if you were delinquent on payments for your student loan or other debts, your score may still be damaged. Raising your score requires time, patience, and financial self-discipline, but it can be done. Here are a few tips for restoring good credit while building financial security for the years to come: