Defaulted on a Student Loan - Now What?

The words "student loan default" can be alarming, but millions of Americans have faced this situation at one time or another. While serious, defaulting on a student loan is not the end of the road.

Student loan debt is considered to be in default after payments have not been made for at least 270 days. Default is a serious situation with lasting consequences, including damage to your credit report, credit score, potential collection fees, garnished wages and tax refunds, and the loss of many benefits associated with federal student loans.

Student loan default also renders you ineligible for further federal loan assistance, including student aid, Federal Housing Administration loans, and Veteran's Affairs home loans (if you would have otherwise qualified).

There are three options to regain many of these lost benefits:

• Repay the entire debt in full.
• Rehabilitate your loan(s).
• Consolidate your defaulted debt.

Since most defaulting borrowers are unable to repay the entire debt in full, many turn to loan rehabilitation or consolidation.

Loan Rehabilitation

Loan rehabilitation is a program designed to remove student loans from default status and undo some of the damage to your credit. When your defaulted loan has been rehabilitated, you regain benefits such as a choice of repayment plan, loan forgiveness, deferment, and forbearance. You recover your eligibility for additional federal loan assistance in the future.

Once your loan is rehabilitated, you also can overcome some of the negative consequences of default. The default status will be removed from your credit report, and any wage or tax refund garnishments will be removed. However, some of the damage to your credit will remain for at least seven years, including the months of missed payments that led to default.

How it Works

The first step is to work with the collection organization assigned to create a reasonable and affordable payment plan for you. For Direct Loans, you'll work with the Department of Education's Default Resolution Group. For older loans, you'll work with a state guaranty agency. If you have defaulted on a Perkins Loan, you should contact the financial aid office of the school from which you received the loan for instructions.

If you are uncertain about which type of loan(s) you have, visit StudentAid.gov and log in to your account. There's information about your federal loans and contact information for your loan servicer.

Your next step is to fulfill your obligation under the new payment plan. You're required to make nine voluntary, on-time, full monthly payments over ten consecutive months. If you successfully make all payments as required, your loan can be considered for rehabilitation, and your lost benefits can be restored.

After rehabilitation, you may find your monthly payments are higher than during rehabilitation. Collection expenses can add up to 18.5% of the principal and interest of the defaulted loan should a guaranty agency have handled your loan rehabilitation.

After completing your loan rehabilitation, explore all your repayment plans, forbearance, and deferment options to ensure that you can successfully manage your debt for the long term.

Loan Consolidation

Another option for dealing with default is to consolidate your debt. When loans are consolidated, a new loan pays off the old loans, and the defaulted loan is marked as "paid in full" on your credit report – but the default status does remain. Since you'll lose the significant benefits of rehabilitation, you should carefully consider whether or not rehabilitation would be a better outcome for your situation before consolidating them.

To qualify for loan consolidation, you'll also need to work with your loan servicer to develop a repayment plan, just like loan rehabilitation. Unlike rehabilitation, which requires on-time payments for nine consecutive months, you can qualify for consolidation after as few as three consecutive months of on-time payments.

You'll want to fully understand what benefits on your original loans may be lost in consolidation. Review our Loan Consolidation material for more information on the pros and cons of consolidation.

Consolidation alone will restore your federal education, Federal Housing Administration, and Veteran's Affairs loan eligibility.

The Bottom Line

Only loan rehabilitation restores your eligibility for further education loans and removes the defaulted status from your credit report. Paying your debt in full or consolidating your debt will help you regain eligibility for education loans. Still, the default status will remain on your credit report.

Consider loan rehabilitation if…

• You want to remove your loan's default status from the national credit bureaus.
• You want to reinstate the loan benefits available before you defaulted – including the ability to consolidate your loan(s).

Consider consolidation if…

• You want to qualify for additional federal loan assistance in as little as three months, compared to nine months for rehabilitation.
• You hold older (FFEL Program) loans and plan to participate in the new Public Service Loan Forgiveness program. Consolidating FFEL loans into Direct Loans without rehabilitation could save six months of payments.
• You are okay with the defaulted status of your original loan remaining on your credit report for seven years.

Dealing responsibly with default is the best way to achieve lasting financial health.