Student loans can be a serious drag on your finances. Collectively, Americans owe $1.4 trillion in student debt, and the average balance for new grads increased by 6 percent from 2015 to 2016.
When your monthly loan payments are high, keeping up with them can be challenging, especially if your budget is tight. When money is scarce, you may even fall behind on your payments.
Missing multiple student loan payments can eventually lead to default. Loan default wreaks havoc on your credit score and triggers an avalanche of collection calls and letters from your lenders.
If you’re in danger of defaulting on your loans, or you’ve already started receiving notices from your loan servicer, don’t ignore the situation. The financial consequences will only worsen.
What is student loan default?
Student loan default means you’ve stopped making payments on your loans.
Before your loans can be in default, they must first be delinquent.
- Your loans are considered delinquent the first day after you miss a payment.
- Your loan stays in delinquent status as long as any payment is outstanding. That means that if you skip your August payment but pay on time for September, you’re still delinquent until you get caught up on the August payment.
- Once you hit the 30-day delinquent mark, your loan servicer can (and is likely to) report your account as late to the three major credit bureaus. That will directly affect your credit score.
With federal direct loans, you’re in default once you miss payments for 270 days, or roughly nine months.
If you’ve got a federal Perkins loan, you could be deemed in default after missing just one payment.
For private student loans, the time frame for default varies from lender to lender. Generally, you’re considered to be in default after you fall behind by 120 days. On private loans, default can be triggered by more than just late payments. If you had a cosigner on your loans, for example, and that person passes away or declares bankruptcy, your loan could go to default status. The same is true if you file bankruptcy yourself or you default on another unrelated loan.
How student loan default affects your credit score
A student loan default on your credit report is extremely damaging to your credit score. Thirty-five percent of your credit score is based on your payment history. A single late payment can knock serious points from your score, and the impact is magnified when you have multiple late payments.
Your credit suffers even more if a private lender assigns the debt to a collection agency. If you’re sued by the lender and the court enters a judgment against you, the judgment could also show up on your credit report, pulling your score down even further.
Your cosigner’s credit score will also take a hit. When a parent or someone else cosigns on your loans, they’re assuming equal responsibility for the debt. If you end up in default, any negative marks associated with the cosigned loan show up on their credit report as well.
Any type of loan default can make your financial life harder. Student loan default can linger on your credit report for up to seven and a half years.
- If you plan to rent an apartment, your landlord may want to run a credit check. If they see that you haven’t paid your loans, they may decide to rent to someone else with a better credit rating.
- If you’re hoping to buy a home down the line, a default in your file could prevent you from getting a mortgage, or could lead to more expensive terms.
- Bad credit caused by default can also make it tougher to qualify for credit cards, personal loans, auto loans or even utility services. Some employers also incorporate a credit check into the hiring process.
In a nutshell, defaulting on your loans is likely to cost you money. You may be locked out of borrowing altogether. If you’re able to qualify for loans or credit cards, the interest rates you pay will likely be higher than they would for someone with a good credit rating.
What else can happen when you default?
Defaulting on your student loans can do more than just damage your credit.
If you default on federal student loans, you could face a number of consequences.
- The entire loan balance could become due immediately. In other words, if you default on a loan, your lender would expect you to repay it in full. That’s a scary thought if you have $30,000 or $40,000 in loans outstanding.
- You become ineligible for deferment or forbearance
- You become ineligible for other benefits, like being able to choose your repayment plan
- You can’t take out any more federal student loans until your default is resolved. That could be a problem if you’re still trying to finish your education and you need to borrow more money to cover tuition.
- The federal government can withhold your tax refund or other federal benefits and apply them to your defaulted loans through an offset.
- Your wages could be garnished if you’re working. If you defaulted because your finances are tight, a wage garnishment could be a huge obstacle to making ends meet.
- Your loan servicer could take you to court to sue you for what’s owed. In the meantime, collection fees, attorney’s fees or court costs could be added on to the total.
- Your academic transcript could be withheld. Your school could decide not to release your academic record until you’re caught up on your loans. If you’re applying to graduate or professional school, that could be a barrier to entry.
For private student loans, the individual lenders determine what actions to take when a borrower defaults. Generally, however, your loan balance would become full and due immediately. Late fees or other penalties could be added on to the balance and you could be sued over the debt. You’d also likely be denied for any additional private loans through the lender.
How to get your student loans out of default
The fastest way to get your loans out of default is to pay what you owe in full. That may not be realistic. If you can’t pay in full, how you approach getting out of default depends on the types of loans you have.
For federal loans, you have two options.
Rehabilitation allows you to work out a payment plan with your loan servicer based on your income to bring your loans current. You must agree in writing to make nine on-time payments within a period of 10 consecutive months.
The amount of your payment is determined by the loan holder and normally equal to 15 percent of your annual discretionary income, divided by 12. Discretionary income means the amount of your adjusted gross income that exceeds 150 percent of the poverty guideline level for your state and household size.
If you can’t afford that amount, you can ask your loan holder to calculate a different payment, based on the amount of income you have left each month after paying your expenses.
If your wages are already being garnished for a defaulted loan, those payments wouldn’t count towards the nine payments required to rehabilitate your loan. Once you’ve made those nine payments, your loans are no longer in default.
The upside of rehabilitation is that it allows you to reinstate your federal aid benefits, including eligibility for deferment, forbearance and loan forgiveness. The default is also removed from your credit history.
You can only rehabilitate your loans once. You won’t get a second chance if you default on your loans again.
You can consolidate your defaulted federal loans into a Direct Consolidation Loan. Essentially, you’re swapping out the old loans for a new loan.
To take this route, you have to agree to repay the new loan using an income-driven repayment plan, or make three consecutive, on-time monthly payments on the defaulted loan before you consolidate it.
One main difference between rehabilitation and consolidation is how they affect your credit. When you consolidate, you gain back all your federal student aid benefits, including deferment and forbearance, but the default isn’t erased from your credit history.
Rescuing private student loans from default
If you default on a private student loan, your remedies vary, based on the lender.
The first thing you can do is ask the lender if they offer a default assistance program. Some lenders may temporarily lower your monthly payments or allow you to put your loans in forbearance if you’re experiencing a legitimate financial hardship. You’ll, of course, need to provide documentation.
You could also consider refinancing your student loans. This is similar to consolidation, in that you will roll your existing loans into a new one. You could hit a snag here, however, if your credit is already tarnished by a history of late payments on your loans. You may need a cosigner to get approved for a refinance loan.
A third option is to offer your loan servicer a settlement. When you settle a debt, you’re asking your creditor to accept less than what’s owed and forgive the remaining balance. If you don’t have a substantial amount of debt and you have cash on hand to bargain with, you may be able to settle your defaulted loans. A settlement would show up on your credit, however.
Don’t procrastinate if you think you may be at risk of default
Student loan default can occur for a number of reasons. If you think there’s even the slightest chance that you may default on your loans, it’s important to think about what you can do to ensure that it doesn’t happen.
If you have federal loans, restructuring your repayment plan could be the solution. Income-driven repayment plans are designed to offer borrowers some flexibility with their payments so they can keep up without feeling overburdened financially. There are four income-driven repayment plans to choose from:
- Revised Pay As You Earn Repayment Plan (REPAYE Plan)
- Pay As You Earn Repayment Plan (PAYE Plan)
- Income-Based Repayment Plan (IBR Plan)
- Income-Contingent Repayment Plan (ICR Plan)
Each of these options uses your income to determine how much you can afford to pay towards your loans each month. For the first three plans, your payment is 10 percent of your discretionary income. For an income-contingent plan, you’d pay the lesser of:
- 20 percent of your discretionary income, or
- What you would pay on a repayment plan with a fixed payment over 12 years, adjusted for your income
While these payment plans can make your payments more manageable, there is a catch. Your repayment period is extended to 20 or 25 years, depending on which plan you choose. The longer you pay on the loans, the more you will pay in interest over the life of the loan.
After you make all of your scheduled payments on a federal loan extended repayment plan, any remaining balance owed will be forgiven. You may owe taxes on the forgiven amount.
If you’re on the verge of default, an income-driven repayment plan could spare you damage to your credit but is virtually guaranteed to cost you more money in the long run.
Income-driven repayment plans aren’t an option with private student loans. Regardless of whether you have federal or private loans, it’s in your best interest to reach out to your lender as soon as possible if you’re worried about defaulting.