Many Americans struggle to pay their student loans. In fact, 10.8% of student loan borrowers are delinquent or in default on payments – that’s 5.5 million people.
On average, 3,000 people default on their loans every single day.
With the student loan crisis worsening over time, and the debt-to-income ratio for recent graduates getting closer to 100%, the expectation is that more and more borrowers will default on their loans.
The current average debt-to-income (DTI) ratio of student loans to income is over 65%. Once your student loan DTI ratio reaches 100%, you can officially not pay back your loans in 10 years or less. You can calculate your DTI by dividing the total amount of your student loans by your yearly salary, and multiple by 100.
Avoiding defaulting on your loans should be a priority for you. So what happens if you default on student loans?
Missing payments will lead to poor credit, increased interest rates, calls from collections agencies, and even garnishment of your wages and tax returns.
The minute that you begin to struggle with your loan payments, you should contact your loan servicer to discuss your options.
Let’s take a look at the consequences of defaulting on your student loan, and how to get yourself out of trouble
What Does It Mean to Default on Your Student Loan
Your student loans are considered to be in “Default” 270 days after you miss your first payment.
Even if you miss or are late with only one payment, but you do not contact your loan servicer to remedy the situation, your account status will change to “Default” after 270 days.
Default status comes with a hefty penalty: your missed payments, total balance, late fees, accrued interest, fines, and penalties will all be due immediately.
Before you ever go into Default status on your loan, your account will change from “Current” to “Delinquent.” This happens as soon as you are late with or miss a payment. You will remain in delinquent status until you contact your loan servicer to make a payment, or request a deferment or forbearance.
270 days after your status changed to Delinquent, with no action taken, it will change to Default.
What Happens If You Default on Student Loans
As soon as you are late on a payment or miss a payment altogether, you will be charged a late fee. Your late fee can accrue interest along with your total balance. Your late fee could be 5% of your monthly payment amount.
Each month that you miss payments, you will be assigned additional late fees. You must contact your loan servicer to find out exactly how much you owe to bring your account back to “Current” status.
Once your account is in Default, your missed payments, total balance, late fees, accrued interest, fines, and penalties will all be due at once. Your loan servicer will hire a collection agency to try to recoup your payment(s), and their fee also falls on you to pay.
Even one missed payment can create a long-lasting problem, since your loan servicer can report that missed payment to credit bureaus. You may find that you cannot be approved for new credit cards or loans, and your credit card interest rates may rise.
It’s possible that you will have trouble borrowing money in the future due to your missed payment.
Federal student loan servicers report late payments to the three major credit bureaus before you officially go into default – after 90 days.
How To Get Student Loans Out of Default
The first step to getting out of default is to contact your loan servicer or the collection agency that has been calling you. Your loan servicer will give you only two options for getting out of default.
The first option will be Consolidation of all of your current loans into one new loan.
The second option is Rehabilitation, in which you make 9 on-time payments of an amount that you and your lender agree upon. After those 9 on-time payments, your loan will be out of default and back in good standing.
Once you are out of default, you will be able to access different repayment plans and can choose an income-based one, with payments that are affordable to you.
There are a few things to consider when choosing between Consolidation and Rehabilitation:
With Rehabilitation, your loan will not be out of default until you have made all nine on-time payments, which can take up to 10 months.
With Consolidation, your loans will be out of default with zero balances as soon as your application is completed, in 60-90 days.
Wage Garnishment Influences Eligibility
With Rehabilitation, you can move forward with the process while your wages or tax refunds are being garnished. However, you must make your 9 on-time payments as your wages are being garnished simultaneously.
With Consolidation, you must have the garnishment order or judgment removed in order to move forward with consolidation.
Your Credit Report
With Rehabilitation, your credit report will reflect that the defaulted loan was removed.
With Consolidation, the previous loan default will remain on your credit report for up to seven years.
Number of Loans
If you are rehabilitating more than one defaulted loan, you will have to go through the process of rehabilitation on each one individually, and make 9 on-time payments for each loan.
With Consolidation, you will combine all of your existing loans into just one payment, with one due date.
Consolidation automatically extends the term of your repayment, allowing for lower monthly payments.
With Rehabilitation, you choose the repayment plan.
With Consolidation, you can switch from variable-rate loans to one fixed-rate loan.
With Rehabilitation, your loan will continue with the same terms you previously had, unless you reach out to your lender and select a new repayment plan.
With both options, collection agencies will stop contacting you once you are out of default.
Total Interest Paid
With Consolidation, you will likely pay more in interest over the course of the loan.
With Rehabilitation, you maintain your loan balance, repayment term, and interest rate unless you choose to change them.
Loss of Benefits
With Rehabilitation, you still have the same loans you started with; that also means that once you are out of default, you still have the same benefits to those loans.
With Consolidation, you have a new loan, and you forfeit the borrower benefits, including interest rate discounts, principal rebates, or loan cancellation benefits that are tied to your current loans.
How To Avoid Going Into Default
The best course of action is to never allow your loans to reach Default status. As soon as you begin to have trouble paying on your loans, you should contact your loan servicer to discuss your options.
You can make a variety of changes to your payment terms that allow you to maintain your “Current” status and preserve your credit score:
- You can choose an income-based repayment plan that lowers your monthly payment amount.
- You can consolidate your loans into one new loan, with one payment amount and one due date.
- You can request a deferment or forbearance.
- If you are late on payments due to a qualifying emergency, your lender may have different options for you.
- If you are late on only one or two payments, speaking with your loan servicer directly will allow you to find out exactly how much you need to pay to achieve “current” status again.
- Set up Auto-Pay or change your due date if remembering when to pay is part of your problem in keeping up with payments.
Another important step to avoiding Default on your loans, is to create a detailed spending plan. By creating and sticking to a budget, you ensure that the money for your loan payments is available when you need it.
How To Recover from Default
Depending on if you choose Rehabilitation or Consolidation to get out of Default, you will have different paths back to financial health. Both options offer unique benefits and challenges, and you’ll have to consider your long-term goals to determine which one is right for you.
If you are looking for a faster path back to “Current” status, Consolidation will get you there in the shortest amount of time. But if you are looking to remove the defaulted loan(s) from your credit report, Rehabilitation is the better choice.
You may also save more money on interest with Rehabilitation, while preserving your loan benefits.
No matter which option you choose, you will be on the road to financial recovery. There are benefits and drawbacks to both Rehabilitation and Consolidation, but both open up new opportunities.
The Bottom Line
Defaulting on your student loans can lead to a myriad of problems. Low credit score, high interest rates, and an inability to be approved for new loans and lines of credit can follow you around for years. This can influence your ability to buy a car or a house, and cost you additional money on your credit card balances.
If you are in default on your student loan(s), you should contact your loan servicer(s) immediately to discuss your options on how to achieve “Current” status.
FAQs on What Happens If You Default on Student Loans
Q: What happens if you default on student loans and leave the country?
There is no statute of limitations on federal student loans. This means that collections efforts can be continued indefinitely, and pick back up when you return to the United States. If you plan to never return to the country, you can potentially dodge your student loan debt. But if you do return, you can expect your credit to be in shambles, making life very difficult. If a family member co-signed on your loans, they will be left with the responsibility of paying your loans in full.
Q: What to do if you default on student loans?
If you default on your student loans, contact your loan servicer immediately. You will need to choose between Rehabilitation and Consolidation to get your loans back in good standing. At that point, you can select a different repayment plan that works with your current budget and future goals.
Q: What happens if you default on private student loans?
Private loans can go into default or collections status earlier than federal student loans, at 120 days late. Once you default on a private student loan, the balance of the loan becomes due immediately. Your loan goes into collections and your credit score is affected. Private lenders can also take you to court to get an order that allows them to garnish your wages, although this process is more complicated than with federal student loans.