Defaulting on your federal student loans can lead to serious consequences, like tax refund offsets and federal benefits intercepts, wage garnishment, and the loss of eligibility for deferment, repayment plans, and probably forbearance. 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.
Unlike most other kinds of loans, borrowers of defaulted federal student loans have the right to get out of default. The two main ways to do this within the federal loan system are:
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 and may require a rehabilitation agreement. Collection fees 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 also continue to accrue.
After you complete your rehabilitation payments, the loan will no longer be in default. Additionally, the servicer will remove all reference to the default status from your credit report. However, late payments will continue to be reported. (Learn more about rehabilitating your federal student loans.)
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. Therefore, collection fees will accrue for a shorter amount of time than under a rehabilitation plan.
When you consolidate, you must choose a servicer for your loan. This opportunity can be an advantage if you had a bad experience with your current servicer. You will also select a repayment plan.
You will have to make three payments before consolidating unless you choose an income-based repayment plan (IBR, PAYE, REPAYE or ICR). If you're married and applying for an income-based repayment plan, your spouse must usually also sign the request. Also, keep in mind that you will have to submit verification of income each year that you are enrolled in an income-based repayment plan.
The default status of the previous loan, as well as late payments, will remain on your credit report for the full amount of time allowed under the Fair Credit Reporting Act.
You can apply for consolidation online at StudentLoans.gov. (Learn more about consolidating your federal, as well as private, student loans.)
A few other options for getting out of default are getting a discharge, repaying the full loan amount, or refinancing the loan.
In certain cases, you might qualify for student loan forgiveness (also called a "discharge"). If you think you qualify for loan forgiveness under one of the many programs, you should apply even if you’re in default. Though you might have to get out of default to be eligible.
Sometimes, it might be possible to pay off a defaulted federal loan in full or to refinance the debt.
If you have money available, it could make sense to pay off the loan to improve your credit and cash flow.
Private lenders usually require a cosigner. Depending on the cosigner’s credit score, a private lender might be willing to refinance your defaulted loan.
Generally, you should consider either of these options only after you’ve determined that rehabilitation, consolidation, and discharge are not available to you.
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.