July 29, 2013
Default on a Student Loan? What to do
Earlier this month, the Senate rejected a proposal to reset interest rates on student loans to their pre-July 1 level of 3.4% instead of doubling to 6.8%. Now, lo and behold, another group of Senators is trying to push through a compromise whereby undergraduates with Stafford loans would pay an interest rate of 3.85% next year. Either way, those with higher education loans are in dire straits.
A snapshot: existing student loans have grown into a trillion dollar marketplace that involves one in every five American households--and for households headed by someone under 35, it's two out of every five for everyone wondering why Millennials aren't yet buying houses, cars or yachts. No matter how you slice it, student loans are big and getting bigger.
So inevitably there are folks out there are concerned about defaulting on a student loan. But what happens if you don't pay?
For a government backed loan, default happens after 270 days of missed payments. The results get nasty pretty fast, and not least because it does serious damage to your credit rating. In the face of default government and private agencies gain immense powers of collection, sometimes well beyond their authority for ordinary debts. For example, while debt collectors typically need a court order to garnish your wages, according to Illinois Legal Aid, to collect a student loan, they get to skip that step and seize 15% automatically through administrative garnishments.
Other items on the parade of horribles include seizing any tax refunds, garnishing Social Security benefits and, of course, a good old fashioned lawsuit.
Your options after a default are somewhat tighter.
First of all, according to Chicago attorney and debt specialist Jarome Lamet, forget about bankruptcy. Although a recent Ninth Circuit decision showed some movement on the issue, as a general rule, student loans simply are not dischargeable through the courts.
"Prior to 2005 if I had a student loan I could go into the bankruptcy court and file a Chapter 7," Lamet said, referring to 2005's bankruptcy reform. "[Today] you cannot use a bankruptcy court for a student loan, private or government backed."
We'll also gloss over Loan Repayment, the first suggestion listed on every reference found, except to say this: no kidding. If you have the cash available to repay your loan in full, do so. There's no excuse for defaulting on payments you can afford.
The two realistic options for someone who has defaulted on his loan and doesn't have the cash to simply make those back payments are rehabilitation and consolidation.
The best option is rehabilitation. Under this program, you and the guarantor decide on a reasonable plan to rehabilitate the defaulted loan, both the number and amount of payments. Once you've voluntarily completed those payments, the loan gets purchased by a new lender, the default gets wiped off your credit score and loan is restored to "current" status.
The benefits here are obvious. You get to purge the default, although not any late or missed payments, from your credit score. You're also no longer subject to collection actions and resume eligibility for financial assistance programs such as forbearance, deferment and loan forgiveness. Finally, rehabilitation is based on negotiated payments with the guarantor, so borrowers with little to no money might still reach some sort of agreement.
Lenders won't let this off without their pound of flesh, however, so be aware that they'll usually add hefty collection fee to the principal of the newly rehabilitated loan. Often these can climb as high as 18.5%, although that's still not as bad as staying in default.
Another option is loan consolidation. Under this approach, you combine all of your loans into one, new note under the federal government. It gets your loans out of default and is almost always quicker than under rehabilitation. A typical consolidation plan will require three on time payments before consolidation, while rehabilitation usually requires between nine and 12.
Keep in mind, though, that you have to make full monthly payments, not a negotiated plan. Consolidation also doesn't erase the default from your credit score, making it generally worth considering only if rehabilitation isn't an option.
Finally, if you can neither make the payments under consolidation nor rehabilitation, your best option is to speak to a lawyer. Virtually every state and city nationwide has legal aid services available for people who can't afford a lawyer, which these days is virtually every citizen nationwide. If you can't reach an agreement with your lender to bring the loan current on your own, seek out one of the services about taking over. Remember, if you simply have no money to make any payments the most important thing you can do is find some (any!) way out of default.
Once the loan is current you can take advantage of income based payment programs to make life a lot easier.
Most of all, the number one thing you can do to help yourself is be proactive. Reach out to your lenders often. Call them, don't make them call you.
Send the first e-mail. The people on the other end of that line don't actually want to give you a hard time, and if they feel like you're negotiating in good faith, they're going to cut you a lot more slack. As a former lawyer who's made these kinds of calls himself, believe me when I say it's the deadbeats they're after, not someone with good intentions going through a rough patch. Give people a reason to help you and, nine times out of ten, they will.
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