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If you default on your federal student loans, here’s what to do next

Kate Dore

March 15, 2019

Few things are more isolating than defaulting on your debt. Especially when that debt is so common, like student loans. But the truth is, you are far from alone. According to a recent Urban Institute report, 22 percent of other borrowers have also defaulted.

It may feel like a worst-case scenario, but federal student loan default does offer a few good options. We have taken a deep dive on federal default—and your best choices going forward.

What is federal student loan default?

When you borrow money from the government to pay for college, you have federal student loans. Default doesn't happen overnight. There are steps to get there—and by understanding those steps—it may be easier to steer clear of them in the future. Here's how federal student loan default actually happens.  

Step one: student loan delinquency

Your loan is “delinquent” in the government’s eyes when your payment is one day late. It may be alarming, but there are a few ways to get back on track. You have three options: 1) pay your outstanding balance, 2) change repayment plans, or 3) apply for help.

If your balance is still due in 90 days, your loan servicer sends a negative report to the three credit bureaus. And, yes, this means your credit will take a hit. If your student loan delinquency continues, default could be the next step.

Step two: student loan default  

When you are delinquent, it's normal to be worried about the next step: student loan default. The problem is, the default timeline isn't the same for every type of federal loan.

If you borrowed from the William D. Ford Federal Direct Loan Program or the Federal Family Education Loan Program (FFEL), you have at least nine months before default. Unfortunately, the Federal Perkins Loan program isn't as generous. Your loan servicer can say your loans are in default anytime you miss a payment.

Step three: consequences of federal student loan default

Defaulting on your federal student loans is a big deal. There are a range of potential consequences to navigate including:

  • Acceleration - Your loan servicer may immediately demand the entire unpaid balance of your loan (including interest!)
  • Loss of federal protections - You may lose the eligibility to change your repayment plan. It’s also possible you will no longer be eligible for deferment or forbearance.
  • Loss of eligibility for student aid - You may lose eligibility for federal student aid.
  • Credit damage - Your loan servicer will report the default to all three credit bureaus.
  • Tax refund garnishment - The government may withhold your future tax refunds or other federal benefits to pay off your outstanding balance.
  • Wage garnishment - The government may ask your employer to withhold a portion of your paycheck to pay off the balance.
  • Court proceedings - Your student loan servicer may sue you to collect the unpaid balance of your loans.
  • School transcript withholding - Your school may withhold your academic transcript until your balance is paid off.

How to get out of federal student loan default

It's easy to get overwhelmed by student loan default. The good news is you haven't sabotaged your financial future. The government offers a few different ways to get back on track.

Regardless of which choice you make, start by calling your loan servicer. An open and honest conversation is often the first step to getting out of default. The sooner you pick up the phone, the better off you will be.

Option one: pay off the balance in full

The first option—which isn't realistic for most borrowers—is making a lump sum payment. Simply log in to your student loan servicer’s portal, make a payment and move on.

If a long-lost relative offers to foot the bill for your unpaid student loan balance—great! Otherwise, don’t worry about the lump sum payoff option. Move along to options two or three.

Option two: loan rehabilitation

Loan rehabilitation is a one-time chance to get out of default and back in your servicer's good graces.

You can get a Direct or FFEL loan out of default by making nine “reasonable” monthly payments within a ten-month period. “Reasonable” usually means 15 percent of your monthly discretionary income—but could be as low as $5 per month.

Perkins loans have stricter requirements—nine full monthly payments. Your servicer decides how much you need to pay.

Rehabilitation takes time, but the benefits may be well worth the effort. Upon completion, your default status goes away and wage garnishment stops. You regain eligibility for deferment, forbearance, different repayment plans, and student aid.

Best of all—the default is erased from your credit report. The one downside is late payments from your loan delinquency won’t be removed.

Option three: loan consolidation

The third option is consolidation. This means paying off one or more of your defaulted federal loans with a new loan. Like rehabilitation, consolidation is a one-time deal.

There are two ways to be eligible. You can join an income-driven repayment plan to pay off the new loan. Or, you can make three on-time, consecutive monthly payments of your defaulted loan before consolidating.

Note: It’s important to know you could hit a road bump if your wages are being garnished. You will need to have the order lifted or judgement removed to continue.   

If you want to get out of default more quickly, avoid preliminary payments, and choose your new loan servicer, consolidation could be a better choice. The downside is you may see higher fees added to your new loan balance. Also, consolidation may be worse for your credit because the default isn’t removed from your reports.

Rehabilitation or consolidation: the choice is yours

When your federal student loans are in default, it's easy to become paralyzed with indecision. Unfortunately, no one can make the decision for you. Rehabilitation and consolidation both have their downsides, but lingering in default is far worse. By making a choice and taking action now, you will be one step closer to improving your credit. You will sleep better knowing there is a brighter financial future ahead.

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