November 13, 2013
New rules ease rehabilitation of defaulted student loan
In a September column, I discussed the three major ways to get out of default on a student loan: repayment, consolidation and rehabilitation. Of the three, rehabilitation is the only way to have a default removed from your credit report. It involves making a series of on-time payments. I described it as a "lengthy process full of red tape."
On November 1, the Department of Education announced new rules designed to make that lengthy process a little bit easier and fairer. The changes come not a moment too soon. As of this month, more than 1 million student loan borrowers who graduated in May will be coming out of their six-month grace periods and entering repayment, and if the last few years are any guide, 177,000 of them will be getting in over their heads into default within three years. Remember, these rule changes apply only to federal student loans, not to private loans.
A loan generally goes into default after missing nine monthly payments. At that point, typically, the loan is being handled by a private debt collector acting on behalf of the federal government. It is to that collector that you must apply to for rehabilitation. Rehabbing a loan means making at least nine "reasonable, affordable" on-time monthly payments within the span of 10 months. From there, you can apply to enter an affordable repayment program such as Income-Based Repayment.
The biggest change in these rules involves the definition of "reasonable and affordable." Previously, debt collectors had often insisted on a payment amount that was at least 1 percent of the total balance of the loan. That means someone earning just $35,000 a year as a starting public school teacher could be saddled with a highly unaffordable $1,000 monthly payment on a $100,000 tab for his master's degree.
Under the new regulations, the loan rehabilitation payment amount must be calculated by the same formula as the Income-Based Repayment program, the affordable federal plan for paying back your student loans.
The IBR formula decides the monthly payment amount based on the borrower's income, not the total loan balance. It's set at 15 percent of discretionary monthly income, where "discretionary" is defined as "marginal amount above 150 percent of the federal poverty line." In the public school teacher example, his rehabilitation payment would be just $222 a month. Borrowers who accept payment plans calculated under this formula also don't have to complete an onerous financial disclosure form that is otherwise required.
The updated regulations include another change designed to help prevent default in the first place. Borrowers who are nine months behind on their payments, the usual line at which delinquency becomes default, can now request forbearance on their loans for up to four months over the phone. Forbearance is a period during which you don't have to pay the loan back. During those four months, the borrower has the option to submit all the written documentation necessary to extend forbearance for a full year.
Finally, there are two more changes in the rules designed to make things easier on borrowers.
One is that once you are in rehabilitation, collection agencies can't contact you to harass you for more money. They are limited to communications required by law and that pertain to the rehabilitation itself.
The other change has to do with wage garnishment. Under federal law, the government has the power to take a slice of your wages to repay a delinquent student loan without taking you to court. Under the new regulations, involuntary wage garnishment will be suspended after five of the nine required rehabilitation payments are made on time.
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