Default is one of those big, scary words.
Defaulting on your student loan is an unfortunate thing, and can have a number of negative consequences.
But there are things you can do to get out of it and fix the damage.
So what is Student Loan Default, anyway?
In the simplest terms a student loan default is a failure to repay your student loan.
If you do not keep up with the repayments, you can fall into default. As a general rule, your loan will only be in default after you have failed to make a payment for 270 days (9 months). During that time you have also failed to make any payment arrangement with your lender or provider. These arrangements include things like deferring your loan, altering your payments or taking out further financing.
You’re not alone
Being in debt can feel like a lonely and scary place. But if you are in default on your student loans you most certainly are not alone.
In 2015, the amount of people who hadn’t made a repayment on their student loans in almost a year rose to nearly 7 million.
That’s right, there are another 7 million people in the same situation as you; loan delinquency and default are a common occurrence. So common, in fact, that 40% of borrowers aren’t making payments.
Student loan debt is massive in the United States with $1.2 trillion being held in debt overall. Your debt is just a drop in the ocean, so the first step is to recognize that the problem is not yours and yours alone. It’s widespread and affects a lot of people.
There are mechanisms in place to deal with it. No one will be shocked that you’ve fallen into default on your student loan, it happens a lot.
The good news is that many people get out of default. There are more flexible repayment plans than ever, and more options for the borrower who falls behind on their payments.
As a result, the amount of people behind on their payments dropped by 3% last year.
If they can do it, you can do it. But how? We’ll get to that shortly, but first you need to fully understand the consequences of being in default.
The reality of default
Even though there are many people in the same situation, it’s still not a situation that you want to be in. The consequences of being in default on your student loans are many and varied. But, the outcomes aren’t pretty. So you really don’t want your loan to stay in default if you can avoid it.
In the short term, you lose a lot. The first thing is that the entire balance of you loan immediately becomes payable, including the interest. So rather than a smaller monthly repayment, they now want the whole thing.
At a stroke you lose the right to loan deferment or forbearance, which were options still available to you.
You also lose the right to any further federal aid.
The default will show up on your credit rating, which could knock it down to poor.
The other thing to remember here is that student loan defaults do not disappear from your credit history after seven years as most other debts do. They stay on there until the entire loan has been paid back.
A long term consequence of default could be the drag factor it has on your credit score – making it difficult to get financing on loans, mortgages or credit card for years after the original default.
It could even have a negative impact on your employment prospects. Studies suggest that 60% of employers check some or all job applicant’s credit histories. The only way to remove the default from your credit report is repayment. There’s no getting around it.
You can’t even escape them via the nuclear option. Federal student loans are not wiped away by bankruptcy.
It’s impossible to avoid repaying your student loans. However, there are different ways to go about paying them back.
But, what will happen if you refuse to pay back your loans and go into default?
Here are some of the consequences you could face.
The government can, by law, ask your employer to deduct up to 15% from your wages in order to repay the debt. The employer doesn’t have the option of saying no.
This is known as “wage garnishment”, and it’s not a pleasant process.
Take your monthly wage and deduct 15% from it. Now imagine the effect of not having that money.
Say you earned $40,000 a year prior to the garnishment. Once it kicks in, it is suddenly as if you’re earning $34,000. It’s effectively like taking a massive pay cut.
This doesn’t only apply to you. If someone has cosigned your loans, or has acted like a guarantor, then legally their wages can be garnished too.
One ray of light here is that they are legally not allowed to take than 25% of your disposable income.
And they are unable to leave you with less than 30 times the Federal minimum wage per week. As currently stands that’s $217.50 per week in disposable income. Health insurance premiums, taxes and retirement plan contributions are factored in to the calculations before they garnish your wages.
But that’s still a heck of a fall in your living standards. Depending on the size of your debt, and the size of your wages, that 15% could take a long time to repay what you owe. Wage garnishment is a long-term issue, and the only way to avoid it is to start repaying.
Forget about tax rebates
Another way the federal government ensures they get their money back is via a tax offset. Essentially, the Department of Education goes to the Treasury and gets them to withhold any tax you’re due back to go towards repaying your debt.
If you file joint returns with your spouse, the IRS will offset their refund as well.
Sounds unfair, but it’s totally legal. This can and will happen.
It’s important to remember though, that these ways of getting money back are last resort options for the federal government. To get to this stage you will have gone through a long process of reminders to pay, questions as to why you aren’t paying, and advice on how to avoid these situations.
Wage garnishment and tax offsets are the two nastiest tools the government uses to ensure your student loan is repaid. If you plan ahead a bit, it would never get to these.
It’s also important to remember that you will receive warning that these processes will apply to you. It won’t just happen out of the blue.
The mechanics of default
Once the whole loan becomes due, the provider will pass your account to a collection agency. When this happens the costs of doing so are added to the money you owe. In real terms, the amount you owe increases the moment this happens. And as time goes on, their running costs will mount. If the situation is a long term one, the end costs could be ruinous.
It’s been calculated that the costs can amount to nearly 20% of the overall amount paid back.
But the financial implications are far from being the only negative consequence of having your debt passed to a collection agency. You need to understand that it’s their job to get that money back, and they’re not going to back off.
The communication from them will be constant.
Regular letters and phone calls. It can feel like you’re being chased day and night.
Every single time they contact you, it’s costing them money to do so, and that cost is added to your debt.
Okay, I get it, I really don’t want to be in default, but how do I get out?
The best way to get out of default is not to get in it in the first place.
Don’t forget that if you’re struggling financially, you have the options of deferment or forbearance. These will temporarily reduce or suspend payments. But this process is only temporary. Sooner or later full payments must resume, even if you can’t afford it.
So assuming the worst does happen and your student loan falls into default, how do you go about getting yourself out of it?
There are four main paths you can take:
- Paying it off
Each method has its merits, but which one is the right one for you?
Refinancing your loan with another loan, known as consolidation is one route that you can choose to go down.
If you’re struggling with several loans, rolling them all into one instantly makes the situation much easier to manage.
You’re only trying to keep track of one payment rather than several.
Another feature of consolidating loans is the length of repayment time. You can repay these loans over thirty years, which can have the effect of bringing down your monthly payment significantly. However, this is a double edged sword. The downside being that if you repay a loan over thirty years that you were originally going to repay over ten, you will end up paying a great deal more in interest.
Interest rates don’t drop on these loans. So in the long run, a consolidation loan could work out more expensive than other options. But in the short term it can bring repayments down to a manageable level, and buy you some time to get your finances in order.
Another option is that of rehabilitating your defaulted loan. In essence, you go to the Department of Education and agree to a monthly amount that you’re willing to pay. This is generally calculated under the same income based affordability criteria as consolidation loans.
If your discretionary income works out at nothing, you are required to make payments of $5. Once you have agreed on a figure, you then need to ensure that you make a minimum of nine payments in a ten month period. Once that’s done, then your loan is effectively rehabilitated.
Be careful at this point though. Often your loan provider will try to switch you to a standard ten year repayment. This can cause your payments to jump significantly. Once your loan has been rehabilitated, you should immediately try to switch to an income based repayment plan to keep your payments affordable.
The advantages of rehabilitation are the relative simplicity, and that you won’t have to pay more than you can afford. Be wary before you enter it though, there are some drawbacks.
The costs of collection may well be added to the loan amount. This can be as much as 16% of the outstanding amount. In addition, wage garnishing will still continue until you’ve made at least five payments, so you are effectively paying out multiple times per month for the same loan.
It’s worth noting that you can only rehabilitate a loan once, so you need to make sure that you’re able to make payments.
Cancellation (also known as forgiveness) sounds like the Holy Grail of loan default. Much like that Grail, it’s not so easy to come by.
Cancellation can occur in some unpleasant circumstances, like the collapse of the institution you went to, death, or disability. But more typically student loan forgiveness is due to a choice of profession.
If you work in government service or for a non-profit for ten years, you can have the full balance of your loan removed.
Work as a teacher for five years, and up to $17,500 will be wiped from your debts.
This sounds wonderful, and it is, to an extent. Certainly the forgiveness of loans means a great deal of debt being wiped off.
But there are drawbacks.
First, you have to work in public service for a minimum of ten years, possibly drawing a lower salary than you could command in the private sector. So it’s only a realistic option for those who wished to go into public service anyway.
Second, Cancellation is not an option for those whose loan is in default. So before you can get that debt wiped off, you’ll need to get your default sorted out via one of the other processes.
Pay it off
As we’ve already seen, being in default means the full balance of the loan falls due. This does mean that you have the option of simply paying the entire thing off. This means you won’t be in default any longer as there simply is no loan on which to be in default.
This is, however, only an option for those that can afford it. Given that the average graduate of the Class of 2016 accumulated $37,172 worth of debt, it seems unlikely that someone would have that sort of money lying around. But if you’ve got some generous friends or family who don’t mind dipping into their pockets, then it may be simplest to just discharge the debt in its entirety.
Speak to your loan provider and find out what they’d accept as a final payment. They may settle for a sum less than the total. Such settlements are difficult, but achievable in some cases.
There are many less than positive outcomes from going into default, and the long term effects can be damaging. It’s important to get a grip on this situation quickly.
But don’t despair. As we’ve seen, not only are a lot of other people in a similar situation, but there are multiple methods to extricate yourself from the financial burden of being in default.
It’s simplest not to go into it.
Making some payment before the 270 days are up can stave off the status of default. But should the worst happen, the key to its successful solution lies in communication. Keep in touch with your providers and work out between yourselves what is the best way to move forward.
Falling into default is bad, but it’s not the end of the world. If you want to know how to get student loans out of default keep a clear head and be realistic about what you can achieve. There may be a period where you don’t have a lot of spare cash. But the bottom line is that these loans, in all but a few special cases, have to be paid off.