When you have student loans, a default is one of the worst situations you can find yourself in. It’s not by any means an uncommon situation, though. According to an Urban Institute report on student debt, in 2016 22% of those surveyed had defaulted in the previous 4 years.
This can have major repercussions, including late fees, more interest accumulating on your loan, and a drop of 60 points or more on your credit score. If you default on federal student loans, the loan servicer can also garnish your wages and withhold federal payments you’re owed, such as tax refunds.
The good news is that you can work your way out of a student loan default, but only if you take action ASAP.
What is a student loan default?
A student loan default occurs when you fail to make your loan payments. Loans typically need to be past-due by a specific amount of time before they go into default. The amount of time depends on the type of loan you have.
If you’re past-due on federal loans, it’s crucial that you check whether they’re in a delinquent or default status. With delinquent loans, there are options available to prevent them from going into default, including changing your repayment plan or applying for deferment or forbearance.
Most federal student loans go into a delinquent status after you miss a payment. Once they reach 270 days past-due, then they go into default. The exception is loans in the Federal Perkins Loans Program, which can go into default as soon as you miss a payment.
With private student loans, you’ll need to review your loan contract or contact the lender to find out how long it takes for the loan to go into default.
How to recover from federal student loan default
Recovery options are different depending on whether you have federal or private student loans. For federal student loans, you have three ways to get out of a default, which are analyzed in the following sections:
- A payoff
- Loan rehabilitation
- Loan consolidation
After defaulting on a federal student loan, the entire remaining balance is due immediately. One way to handle the situation is to pay off the full amount.
There’s not much to say about this option, because it won’t be realistic for most borrowers whose loans have gone into default. After all, if you had the money lying around to pay off your student loans in full, you probably would have used that to make your payments and avoid a default in the first place.
Loan rehabilitation is the most effective way to recover from a federal student loan default, because if you complete it, then the default gets taken off your credit history. This can help your credit score quite a bit.
You’re only allowed to rehabilitate a defaulted loan once. If you default on that loan again, loan rehabilitation is no longer an option. Also keep in mind that it won’t remove any reported late payments, so those will still affect your credit.
Here’s how loan rehabilitation works:
- You contact your loan servicer to start the process.
- The loan servicer will set a monthly payment amount equal to 15% of your discretionary income. You’ll need to provide income verification for this.
- You must make nine payments within 10 consecutive months.
If the loan servicer has been collecting on your loan through wage garnishment or other methods, they can continue to do so during the rehabilitation process. The amount they collect doesn’t count towards your monthly payments.
Can’t afford the monthly payment your loan servicer calculates? All is not lost. You can submit verification of your income and all your monthly expenses. The loan servicer will then provide an alternative payment amount based on how much income remains after taking your expenses into account.
After you complete loan rehabilitation, your student loan will no longer be in a default status, and any collections will stop. You’ll regain all the previous federal loan benefits you had, including:
- Eligibility for deferment and forbearance
- Your choice of income-based repayment plans
- Eligibility for loan forgiveness
- Eligibility to receive further federal student aid
Loan consolidation is faster than loan rehabilitation, but it won’t remove the default from your credit history. It will, however, get your loan out of default and restore all the previous federal loan benefits you had.
There are two ways to consolidate a student loan in default:
- Agree to an income-based repayment plan for your Direct Consolidation Loan.
- Make three consecutive, on-time, full monthly payments before consolidating your loan. This allows you to choose any repayment plan you want. The loan servicer will determine the amount of your three required payments if you choose this method.
Before we go any further, you should know that you can’t consolidate a loan that the servicer is collecting through wage garnishment or a court order from a judgement against you. If either of those applies to you, then first you’ll need to get the wage garnishment lifted or the judgement vacated.
In addition, there are other rules to consider if you’re consolidating one of the following types of loans:
- A defaulted Direct Consolidation Loan: You must be consolidating at least one other eligible loan in addition to your Direct Consolidation Loan. If you don’t have another eligible loan, then you can’t consolidate and must instead opt for loan rehabilitation or a full repayment.
- A defaulted FFEL Consolidation Loan: If you have no other eligible loans to consolidate, then you can still consolidate your FFEL Consolidation Loan to get it out of default, but you must agree to an income-based repayment plan.
- A defaulted Parent PLUS Loan: The only income-based repayment plan available when consolidating this type of loan is the Income-Contingent Repayment Plan (ICR Plan).
How to recover from private student loan default
Unlike federal loans, private student loans don’t have standardized options that can remove them from a default status. Instead, your recovery options will depend on the lender and whether they’ve sent the debt to a collection agency.
If the debt hasn’t gone to a collection agency, then the first thing you should do is contact your lender, explain your situation, and see what they can offer you.
Options could include:
- Forbearance: A period when you don’t need to make your loan payments, giving you a chance to improve your financial situation. Your loan will still accumulate interest during this time, so you should start making payments again as soon as you can.
- A lower payment amount (temporarily): Some lenders will let you set up a new repayment plan, at least while you get back on your feet.
If the debt has gone to a collection agency, then you’ll need to negotiate with them. Fortunately, collection agencies are often open to making a deal, as receiving a portion of the debt is better than nothing.
You could try to set up a repayment plan with the collection agency, or, if you have some money saved, you could also see if they’ll accept a lump sum to settle your debt. Make sure you get any deal in writing so that you have proof of it.
Can you discharge defaulted student loans with bankruptcy?
It’s possible to discharge both federal and private student loan debt by declaring bankruptcy, but only if you file an adversary proceeding and can prove the following three things to the bankruptcy court:
- You wouldn’t be able to maintain a minimal standard of living if you were forced to repay your student loans.
- Your hardship from your student loans would continue for a large portion of the repayment period.
- You made a good faith effort to repay your student loans.
There are four potential outcomes:
- Your student loan debt is fully discharged.
- Your student loan debt is partially discharged.
- None of your student loan debt is discharged, but you can get different terms, such as a smaller payment amount or lower interest rate.
- None of your student loan debt is discharged and the terms remain the same.
Although there’s no guarantee you’ll be able to discharge your student loan debt in bankruptcy, it could happen depending on the court and your specific financial situation.
You should only use bankruptcy as a last resort, though. It takes years for your credit to recover from a bankruptcy, so you should make sure you’ve exhausted your other recovery options first.
Bringing your student loans back from a default
As stressful as it can be when you’ve defaulted on student loans, the situation isn’t hopeless. You can recover from a student loan default, and in many cases, you’ll be able to work with your lender to get back on track.