According to chamberofcommerce.org, one-quarter of student loan borrowers (10.3 million) owe $40,000 or more in federal student loans. And for many, repaying those loans will be a challenge. But defaulting on your federal student loans can lead to severe consequences, like:
You might also find continuing your education or returning to school difficult because the Department of Education can deny you eligibility for new education grants or loans.
If you go into default on your federal student loans, you might be able to resolve the matter by rehabilitating your loans or consolidating them.
If your FFEL or Direct Loan payments are due monthly, default will occur after 270 days—about nine months—of missed payments. If your payments are due less frequently than monthly, default occurs after 330 days of missed payments, about 11 months.
But a Perkins loan is in default as soon as you miss a payment or violate any other term of the payment agreement.
To rehabilitate a defaulted student loan, you must make nine payments within 20 days of the due date over the course of ten months. The servicer will set the amount of the payments.
You must submit information about your income, and the servicer will calculate a "reasonable and affordable" monthly payment based on that information and the federal poverty guidelines.
First, the servicer will find 150% of the poverty level for your family size. Then, the servicer will then determine your "discretionary income" by subtracting the amount from your adjusted gross income (AGI) in your most recent tax return. The payment will be equal to 15% of your discretionary income.
If the amount is still more than you can afford, you may submit documentation of your expenses. The servicer can determine a lower payment by deducting reasonable expenses. In all cases, the payment must be at least $5 per month.
Once your payment has been set, your servicer will send you documentation of the payment amount, which may require a rehabilitation agreement.
Collection fees usually will continue to accrue on your loan as long as it is in default and can be as much as 18.5% of the loan balance. These fees are in addition to the interest, which will normally continue to accrue.
After completing your rehabilitation payments, the loan will no longer be in default. The servicer will remove all references to the default status from your credit reports. But the previous late payments will continue to be reported.
Nearly all defaulted federal student loans can be consolidated into a Direct Consolidation Loan. Combining your student loans through consolidation is a faster and cheaper way to get out of default on federal student loans than rehabilitation.
You don't have to pay fees to consolidate your loan, and consolidation should be completed in fewer than six months. So, collection fees will accrue for a shorter amount of time than under a rehabilitation plan.
However, be sure to consider the pros and cons of federal student loan consolidation (see below) before taking this step. First, here are some basics about the program.
When you consolidate, you must choose a servicer for your loan. This opportunity can be advantageous if you've had a bad experience with your current servicer. You will also select a repayment plan.
You'll have to make three payments before consolidating unless you choose an income-based repayment plan. If you're married and applying for an income-based repayment plan, your spouse must usually also sign the request.
Also, remember that you must submit income verification each year that you're enrolled in an income-based repayment plan.
The default status of the previous loan and late payments will remain on your credit reports for the total amount of time allowed under the Fair Credit Reporting Act.
Before you move forward with a Direct Consolidation Loan, consider both the advantages and disadvantages.
Consolidating your federal student loans into a Direct Consolidation Loan offers some potential advantages.
Consolidating your loans could lead to lower monthly payments because the repayment term is extended up to 30 years.
Direct Consolidation Loans have a fixed interest rate. Since July 1, 2006, all federal student loans have a fixed interest rate. But if you have federal loans, except Perkins Loans, that were disbursed before this date, you might have a variable interest rate on one or more of your loans. If the variable rate loans that you're consolidating currently have low rates, you can lock in a fixed low rate by consolidating.
The new interest rate is determined based on the weighted average of the interest rates on the loans being consolidated, rounded up to the nearest one-eighth of a percent.
After your loans are consolidated, you'll only have to make one payment each month instead of multiple payments on various loans. For many people, keeping track of their student loan balance is easier.
By consolidating, you might get access to a repayment plan that wasn't previously available to you. You can repay a Direct Consolidation Loan, in most cases, with:
Consolidated loans are eligible for the PSLF program. So, federal loans originating under the FFEL program or the Perkins loan program can be consolidated into a new Direct Consolidation Loan to qualify for PSLF. Otherwise, these kinds of loans usually aren't eligible for the PSLF program.
But including a Perkins Loan in a consolidation loan will cause the loss of other specific cancellation benefits only available for that program.
With a Direct Consolidation Loan, you'll get access to income-based repayment plans that provide loan forgiveness.
The following are a few potential downsides to consolidating your federal student loans under the Direct Consolidation Loan program.
Again, consolidation will extend the repayment period—perhaps to 30 years—which lowers the monthly payment. But you'll pay more interest over the life of your loan. If you've just about paid off your student loans, it might not be worthwhile to consolidate.
Also, because the rate is based on the average rate of your consolidated loans, the rate on a consolidation loan might be higher than it was on some of the loans before you consolidated. So, if you have one or more loans with significantly higher interest rates, it might make sense not to consolidate those loans and instead focus on trying to pay them off more quickly.
With a Direct Consolidation Loan, you don't get a grace period. The repayment period starts immediately upon consolidation, and the first payment will be due in around 60 days.
However, if any of the loans you want to consolidate are still in the grace period, you can delay the processing of a Direct Consolidation Loan until the end of a grace period if you make this selection in the application.
If you were in default, your report will reflect that your previous loans were in default but are now paid in full through the new loan. So, consolidating your loans won't immediately help your credit. But if your payments are affordable after you consolidate and you continue to make on-time payments, your credit scores will begin to improve.
On the other hand, if you rehabilitate your federal student loans, the lender will remove the default from your credit history (but not your history of late payments).
You don't get to count any payments that you made on a loan before you consolidated for loan forgiveness requirements; consolidation restarts the clock on loan forgiveness programs. So, you lose credit for any payments made toward forgiveness, like income-driven repayment plan forgiveness and PSLF.
By consolidating, you could lose other benefits, like reduced interest rates, principal rebates, repayment incentive programs, or loan cancellation benefits that are available under the loans that you're consolidating. Again, if you include a Perkins Loan in the consolidation, you'll lose certain cancellation benefits only available from that program.
Both rehabilitation and consolidation are available only once for each federal student loan. But it's possible to consolidate just one loan. So, you could get out of default quickly on a particular loan while retaining the ability to consolidate other federal student loans if you default on a different one.
To consolidate or to start a loan rehabilitation arrangement related to your defaulted federal student loans, contact the Department of Education's Default Resolution Group, or call them at 800-621-3115 (TTY for the deaf or hearing-impaired 877-825-9923) for assistance.
A few other options for getting out of default are getting a discharge, repaying the full loan amount, or refinancing the loan.
In some cases, you might qualify for student loan forgiveness (also called a loan "discharge" or "cancellation"). If you think you qualify for loan forgiveness under one of the many programs, you should apply even if you're in default. However, you might have to get out of default to qualify.
If you have money available, it could make sense to pay off the loan.
Private lenders usually require a cosigner. Depending on the cosigner's credit scores, a private lender might be willing to refinance your defaulted loan.
Sometimes, it makes sense to refinance a federal student loan as a private loan. But you'll lose access to federal repayment plans, repayment incentives, and forgiveness programs. Make sure that it's in your best interest to refinance before you do so. It usually isn't.
To find out more about how to get out of default, ask your servicer.
If you need help dealing with your servicer or need information about your available options, consider consulting with a student loan attorney or debt settlement attorney who deals with student loans.
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