There are enough lower payment, deferment and other options available for federal student loan borrowers that one would hope defaults on these loans would be a rare occurrence.
Unfortunately, statistics show that more than 14 percent of federal student loan borrowers who left or completed school in 2010 and more than 18 percent of loans for students who left or completed school in 2008 had defaulted by 2014 . The numbers get grimmer when you start looking at individual school types, with some having lifetime default rates as high as 40 percent.
Many consumers assume that once you default, your only choices are to pay off or try and hide to avoid the consequences. The good news is that there are actually several options available to help you recover from default, and in some cases, maybe even repair your credit score a little bit.
[Follow a timeline of federal student loan delinquency, default consequences.]
Rehabilitation
If your credit score is a priority, rehabilitating your defaulted student loan may be a good choice. Under this option, the borrower agrees to a reasonable payment amount with the loan holder and makes that payment on-time for nine consecutive payments.
Once rehabilitation is completed, the loan is put back into regular servicing, the collection costs are reduced to 16 percent — they can be as high as 24 percent otherwise, and up to 40 percent for Perkins loans. And the default line is removed from the borrower’s credit report. Keep in mind that the delinquencies that led up to the default will remain on your credit for the normal time frame, which is generally seven years. But having that default line removed can make a significant, positive impact to your credit report.
The Fine Print
Like many student loan rules, there are a few details of rehabilitation you need to be aware of. First, these federal loans can only go through the rehabilitation process once per loan unless the prior rehabilitation occurred before Aug. 14, 2008. Also, if you miss a payment during the process, you’ll most likely be required to start all over again. A borrower can become eligible for additional federal aid after the sixth on-time payment, but will lose it again if they miss future payments or don’t complete the rehabilitation process.
The initial payment amount you’ll be offered will be about 15 percent of your discretionary income, which is defined as adjusted gross income minus 150 percent of the poverty line for your state and family size. If that’s too high for you, you can request a financial hardship form, which will allow you to have many of your living expenses to be taken into consideration. This will often result in a lower rehabilitation payment.
If you are currently having your wages garnished, that can also be taken into consideration. After five voluntary rehabilitation payments, the garnishment will cease unless you do not continue your voluntary rehabilitation payments. For either payment formula, you will be required to submit a signed rehabilitation agreement and proof of income and expenses as applicable before the process can be completed.
[Read the 11 terms you need to know before repaying student loans.]
A Word of Caution
While the current rehabilitation rules help make it easier for borrowers to take advantage of the program, it’s not necessarily a good idea for everyone. A borrower who has to use the financial hardship form to find an affordable payment amount may be laying a path for failure down the road.
There are no lower payment options available for non-defaulted federal student loans that take the borrower’s expenses into account. This means it’s very possible that a post-rehabilitation borrower who used the financial hardship form method may find he is unable to afford the lowest payment option available once the loan is rehabilitated, and therefore be at higher risk for defaulting again.
Defaulting again means a second round of collection costs in addition to the typical consequences. If a borrower with a defaulted loan cannot afford the 15 percent formula, which is similar to the one used for income-based repayment, it might be a good idea to ensure there’s a post-default repayment plan that will be affordable before he proceeds.
Consider Consolidation
If rehabilitation is not an option, consolidation could be. Defaulted federal loan borrowers can generally have their loans released for consolidation after making a short satisfactory repayment agreement with the loan holder. This could take some additional time if the loan is under administrative wage garnishment or litigation.
In the case of consolidation, while the default and all prior delinquencies remain on the credit report, it will show that the defaulted loan has been paid in full by consolidation. Collection costs for consolidation are no more than 18 percent, which can be significantly lower than those charged for straight collections. A loan can be consolidated out of default an unlimited amount of times — but remember that every time the loan defaults, additional collection costs are added.
Because consolidation can be quicker than rehabilitation, this might be a good option for a borrower who is trying to return to school in the near future, and for whom their credit score is not a priority.
[See how income-driven student loan repayment plans can cost more.]
Pay In Full
While not an option for most borrowers, paying the loan in full is another way to resolve a defaulted student loan. The loan will show as paid in full on the borrower’s credit report, but will still show the past default and delinquencies for the normal credit history time frame. While there is no guarantee, paying the loan in full may allow the borrower to request a reduction in collection costs.
Once a loan is out of default, whether through rehabilitation or consolidation, the loan is again eligible for all lower payment, deferment and other options available prior to the default. The consumer also is again eligible for additional federal student aid.
More from U.S. News
Understand the Consequences of Student Loan Default
A Timeline of Federal Student Loan Delinquency, Default Consequences
Avoid These Student Loan Challenges for Community College Students
Look to Rehabilitation to Recover from Student Loan Default originally appeared on usnews.com
