Many people take out student loans to finance their education. But what happens if you can't manage those monthly loan payments once you graduate? If you take out federal loans for college and go too long without making a payment, your loan will become delinquent, and you'll risk going into default. And that could have serious consequences.
What is federal loan delinquency?
When you take out federal loans for college, you're required to pay back that debt on a monthly basis once your grace period ends. If you miss a payment, however, your loan becomes delinquent.
Now, if you quickly make up that missed payment, it won't be such a big deal. But once you’ve been delinquent on your student debt for 90 days, you'll risk having that delinquency reported to the three major credit bureaus, which will in turn bring down your credit score. Once that happens, you may have a hard time borrowing money the next time you need to.
When do federal loans go into default?
Loans that stay delinquent for too long risk going into default. You're officially considered to be in default on federal student debt once you've gone 270 days without a payment. Keep in mind that the 270-day mark applies to federal loans, not private ones. If you borrowed privately, you could be considered to be in default as soon as you miss a single payment (although usually, you're not considered to have defaulted until you go three or four months without a payment).
The consequences of defaulting on federal student loans
Once your federal loans are officially in default, the U.S. government can mandate that you immediately repay your entire loan balance, plus any accrued interest on that sum. At that point, you're no longer eligible for the various borrower protections associated with federal loans, like deferment, forbearance, or the ability to get on an income-driven repayment plan.
If you can't immediately repay your loan, the U.S. government can actually come after your wages. Now, you will receive 30 days’ notice that your wages are scheduled to be garnished, and you'll then have the right to request a hearing to appeal it. But unless you're able to bring your loan payments up to date, the government will be able to seize a portion of your wages. The same holds true for your tax refund -- the government can snatch it if you’re in default on your federal loans.
Furthermore, the fact that you've defaulted on your student debt will be reported to the major credit bureaus. And you know what that means -- you can kiss your decent credit score goodbye, because it's going to take a massive hit. Once that happens, it can take you years to recover.
And one other thing -- in some cases, the college you attended may withhold your academic transcript until your loan situation is resolved. This could be a problem if you're applying to graduate school or need that information for some other purpose (although not every school will go this route, and the decision is at each college's discretion).
Getting out of default
Once you’ve defaulted on your student debt, it’s best to escape the situation as quickly as possible, and you have three options in this regard. The first is to pay off your loan balance in full, although chances are that if you were struggling to the point that you landed in default in the first place, that option is off the table.
Your next option is to pursue a loan rehabilitation agreement. Under this type of agreement, your loan holder will come up with a reasonable monthly payment that you’re required to make nine times to get out of default. That monthly payment will equal 15% of your yearly discretionary income, divided by 12.
Discretionary income is the amount of your adjusted gross income (as reported on your most recent federal tax return) that exceeds 150% of the poverty guideline for your family size and state. This means that if your discretionary income is $40,000, you’ll be looking at a $500 monthly payment ($40,000 x 15% = $6,000; $6,000 / 12 = $500).
Unfortunately, your wages will continue to be garnished while you’re making those nine payments under your rehabilitation agreement. Not only that, but any payments that are considered involuntary (such as payments that come in the form of garnished wages) don’t count toward your nine required rehabilitation payments.
Your third option for getting out of default is to consolidate your defaulted federal student loan into a Direct Consolidation Loan. This option is only on the table if you’ve taken on at least one other loan that is eligible for this program. If you don’t, and you can’t repay your entire loan balance, you’ll need to get yourself on a rehabilitation plan.
But if you are eligible for a Direct Consolidation Loan, you must agree to repay that new loan under an income-driven repayment plan, or make three consecutive, on-time, voluntary payments on that loan before consolidating it. If you opt for the latter, the payment amount in question will be decided by your loan holder, but will be capped at a reasonable number based on your income.
Once your new Direct Consolidation Loan is in place, you'll get the option to continue to pay it off via an income-driven repayment plan.
Recovering from a federal student loan default
The ease with which you’re able to recover from defaulting on your federal student loan will depend on the path you take to get out of it. If you fulfill your obligations under a rehabilitation agreement, your loan will no longer be considered in default, which means any wage garnishments you were subject to will stop. You’ll also once again become eligible for an income-driven repayment plan, deferment, or forbearance. Just as importantly, the record of your defaulted loan will be removed from your credit history (although your record will continue to show late payments that were reported prior to your actual default).
If you use a Direct Consolidation Loan to get out of default and fulfill the obligations outlined above, you’ll be in the clear -- meaning your wages won’t be garnished anymore, and you’ll be eligible for borrower protections like deferment and forbearance. However, that default will remain on your credit report.
Avoiding a federal student loan default
Clearly, defaulting on your federal student loans isn't something you want to do. That's why it pays to get ahead of the situation the moment you start struggling to make your payments. The good news is that, as mentioned earlier, federal loans offer a number of borrower protections that make the repayment process more manageable, so don't hesitate to pursue them.
- Income-driven repayment plans: One option you can explore is an income-driven repayment plan. Under one of these plans, your monthly student loan payments will be recalculated as a reasonable percentage of your income (anywhere from 10% to 20%, depending on the specific repayment plan you're eligible for). Not only that, but if you stick to that plan, your remaining loan balance will be forgiven after 20 to 25 years, even if it's not gone by then.
- Deferment or forbearance: If you really can't afford to pay any amount toward your loans -- say, you've lost your job or have encountered another financial hardship -- you can look into deferment or forbearance. Both options allow you to pause your payments for a period of time without penalty (meaning you won't be considered to be delinquent on your debt if you don't pay). With deferment, you might avoid accruing interest on your outstanding loan balance during the period in which you're not making payments. With forbearance, you will accrue interest.
Deferment also allows for a longer period without payments. You can defer your loan payments for up to three years if you qualify, whereas forbearance will only allow you to stop making payments for a year.
Keep in mind that when you get yourself on an income-driven repayment plan, or seek relief via deferment or forbearance, you often end up extending the life of your loan. But if you can't keep up with your current payments, it is better than defaulting on the loan.
Don’t forget that all of the above applies to federal student loans. If you took out private loans for college, the aforementioned programs don’t exist, at least not officially. However, you can still reach out to your lender and attempt to negotiate your repayment terms. Your lender might agree to recalculate your monthly payments so that they’re more affordable, or even allow you to defer payments for a period of time.
Defaulting on federal student loans is bad news. If you’re struggling to keep up with your debt, explore the aforementioned protections before you give up and stop making payments altogether.