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How to Avoid Student Loan Default

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In September 2018, the US Department of Education reported that “the Fiscal Year 2015 national federal student loan cohort default rate decreased by 6.1% compared to the FY 2014 national rate, from 11.5% to 10.8%.”

The good news is that the number of student loan borrowers in default is trending down. However, there are still a lot of borrowers in default and even more in delinquency.

If you are in delinquency or default it can feel overwhelming, but there are some actionable steps that you can take to move forward and get back on track.

Delinquency Vs. Default

Two important terms that all borrowers should know. Delinquency is when you miss a single payment on your student loan. Default is when you have missed a determined number of days of payment. The Department of Education defines default as more than 90 days without a student loan payment. If you have a private lender you should review its delinquency policy, as it might be different.

What happens if I default on my student loans?

  • The default is reported to the three major credit bureaus, and your credit score will take a hit.
  • For a federal loan, your wages can be garnished by up to 15% of disposable pay.
  • The government can also deduct money from your Social Security benefits, disability checks, or tax return to make payments toward your federal loan.
  • Additional monetary penalties can be added to the loan due.
  • The government could sue you in court.

4 Ways to Avoid Defaulting on Student Loans

If you are in delinquency because you missed a payment, the most important step you can take now is getting out of delinquency.

Borrow only what you need

If you are still in school and are looking to avoid defaulting in the future, borrowing only what you need is a proactive measure that you can take. Budget your education-related expenses and make sure you are not taking out further loan money unnecessarily

Talk to the lender

As with everything in life, ignoring the problem does not mean it will go away. If you are in default or delinquency you should be talking with your loan lender and making a strategy.

There might be repayment or deferment options available that you didn’t know about, and could give you some short-term relief.

If you’re not sure who services your student loans now is the time to get acquainted. The Department of Education can help you figure out which servicer you work with and will need to contact.

Deferment or forbearance

If you are having short-term cash flow problems, you might be able to apply for deferment or forbearance with your loan provider, to suspend payments for a short time. In forbearance, your loan will continue to accrue interest while you are not making payments, leading to a larger bill in the long-run.

Deferment could mean that you won’t accrue interest while not making payments. If you are eligible for both, always pick deferment.  

An income-driven repayment plan

Maybe your cash-flow concerns are a persistent concern and you need a longer-term strategy to get in control of payments. If you qualify for income-driven repayment and have a qualifying federal loan, then it can be a solution for borrowers needing relief. While it can be a short-term relief and solution by lowering your monthly bill, it can also extend your repayment term and be much more expensive over the life of the loan.

3 Ways to Get Student Loans Out of Default

If you find yourself in default, there are options to get your loans back under your control.

Repayment in full

One option for getting out of default is to repay your student loans in full. Unfortunately, this is not generally an option that borrowers in default will have access to. 

Loan rehabilitation

According to the Federal Student Loan website, rehabilitation means “you must sign an agreement to make a series of nine monthly payments over a period of 10 consecutive months.”

The payment will be decided based on your income and is designed to be something that the borrower could reasonably afford. At the end of the process, if the borrower has made the required on time the default status will be removed from the borrowers’ credit history.

While your credit history will still show that you made late payments on your student loans, removing the default from your credit history is a huge benefit. If your wages were being garnished by the government that will also stop once finishing loan rehabilitation. You will again be eligible for deferment or forbearance if a short-term cash flow issue came up.   

The requirements are different for each kind of federal loan, so be sure to check out the Federal Student Loan website to see what is required for your loan.

Loan consolidation

Borrowers with federal student loans in default can apply for a Direct Consolidation Loan to try and combine many payments into a single loan and hopefully receive a lower interest rate. Direct Consolidation Loan holders are also eligible for a number of income-driven repayment plans that could help.

According to the Department of Education, to consolidate a defaulted federal student loan into a Direct Consolidation Loan, you must either:

  • Agree to repay the new Direct Consolidation Loan under an income-driven repayment plan, or
  • Make three consecutive, voluntary, on-time, full monthly payments on the defaulted loan before you consolidate it.

While a good option for those who can’t make their current monthly payments, accepting a lower interest rate might also come with a longer term. Over the life of the loan, you might find yourself paying significantly more than the principal borrowed originally.

Consolidation also does not come with the benefit of the default being removed from the borrower’s credit history. If you have been using an income-driven repayment plan consolidation will reset any progress already made. Each federal loan type will have its own considerations when consolidating, so be sure to check out the Department of Education website to learn more about your loan.

Loan Rehabilitation Vs. Consolidation

Benefit Regained  Loan Rehabilitation Loan Consolidation
Eligibility for Deferment Yes Yes
Eligibility for Forbearance Yes Yes
Eligibility for Repayment Plans Yes Yes*
Eligibility for Loan Forgiveness Programs Yes Yes
Removal of the Record of Default From Your Credit History Yes*  No
Source: Federal Student Aid Website

This article was written by Carolyn Pairitz Morris, Senior Editor at Earnest.

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Disclaimer: This blog post provides personal finance educational information, and it is not intended to provide legal, financial, or tax advice.