November 17, 2012

Saving Your Personal Finances: Getting Out of Student Loan Default

“We continue to be concerned about default rates and want to ensure that all borrowers have the tools to manage their debt,” - U.S. Secretary of Education Arne Duncan

Student loan default is a terrifying and ambiguous term used to define student loans that have been delinquent for 90 consecutive days. Essentially it means that lenders have lost confidence that the loan will be repaid. During this period, loans will be subject to hefty collection fees, 25-40%, depending on the type of loan.

So basically, once a borrower misses three months of payments, in a row, they will be subject to a litany of financially painfully and emotionally trying consequences.

As tuition increases more families have begun to rely on student loans as a means to pay for college – the US Federal government issued 37 million borrowers loans between 2007 and 20102, this problem is turning to a pandemic. The rate of student loan default hovers at roughly 13.8%, 5.9 million borrowers who owe $76 billion, according to the Department of Education. For-profit institutions, like the University of Phoenix, have the highest default rate, 22.7%, followed by public university with an 11% default rate and private, non-profit colleges at 7.5%.

What Happens During Default

Within 90 days of default, lenders will contact all major credit agencies and borrowers will immediately see a reduction to their credit score. As their credit score continues to fall, they will be unable to apply for rental applications, auto loans, or credit cards. Collection agencies will also begin contacting borrowers at home and work, something many describe as behavior verging on harassment.

If the default persists, and the IRS is able to find the information, borrowers’ wages will be garnished and it is possible that funds from the borrowers bank account will be withdrawn. It is also not uncommon for the IRS to take those who defaulted to court.

Out of the Red, but Not in the Clear

While the consequences of default are severe, there are also many resources that can help borrowers get their personal finance back on track. There are a multitude of grants and assistance programs available; however, the borrower must get their loan out of default before they become eligible for them.

The two most common default exit strategies are consolidation and rehabilitation, but before considering their of these options, make an honest assessment of whether or not it will be possible to meet the new requirements. Both strategies will only be offered once per loan.

Consolidation: Loan consolidation means that a borrower has taken out a new loan that repays all of the outstanding loans in that borrower’s name, which essentially gives borrowers are able to start fresh, a new loan, and a new lender. A new loan will allow borrowers to be eligible for grants and deferment. Additionally, borrowers are only responsible for one monthly payment and, depending on when they took out their loans, may receive a lower interest rate. However, this option can be dangerous for borrowers looking to consolidate their Federal loans with a private company; once that happens, those borrowers will be ineligible for many government assistance programs.

In order to consolidate defaulted loans, borrowers must apply for the new loan, a process that may take some time as banks and government agencies will need to recalculate the payment amount.

Rehabilitation: To be eligible for loan rehabilitation, a federally mandated options lenders must give borrowers to bring their loans out of default, borrowers must make demonstrate they are able to make reasonable and affordable payments within 20 days of the payment’s due date for nine out of ten consecutive months. If one than one payment is missed, the process will start over again. Once rehabilitation is complete, borrowers will be removed from default status and be allowed to apply for grants and assistance.

In order to use loan rehabilitation, borrowers will have to request it from their lender or collection agency. The most important thing to remember is to get the agreement in writing, or there will not be proof that this option was offered.
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