Defaulting on a student loan triggers credit-altering events
The fallout from defaulting on government student loans
- Defaulting on a student loan can ruin your credit rating and prevent you from receiving additional federal student aid.
- You cannot apply for a deferral or forbearance on your student loan if you are in default.
- Loan rehabilitation and loan consolidation can help you get out of default on a student loan.
- You also can refinance your student loan with a private lender, but your loan terms can be affected by delinquencies and defaults.
If you default on a loan, you can face severe consequences, including being forced to repay the entire balance of your loan, having your loan assigned to a collection agency, getting your wages garnished to repay the loan and having your credit rating ruined for years to come. If you default on a government student loan, you also lose some of the benefits of taking out that government-backed loan in the first place, including your eligibility to pursue deferment or forbearance on the loan. You also will lose the ability to receive additional federal student aid.
A government student loan becomes delinquent any time you miss a payment. If you are delinquent for more than 90 days — miss three payments — that delinquency will be reported to the three major credit bureaus, which will harm your credit rating. If you do not make your loan payments for 270 days — missing nine payments — your loan will go into default. In addition to the consequences listed earlier, defaulting can increase your student loan debt because of late fees, additional interest, and court and collection fees.
Getting out of default
If you default on your student loan, there are options other than facing collection agencies and wage garnishment. You can repay the loan in full. One possible way to do this is to refinance your student loan through a private lender. Compare lenders to see what rates are available to you. If you have already defaulted, however, you may not be able to refinance, or may end up with less-than-ideal loan terms because of the hit to your credit rating.
Two better options are loan rehabilitation and loan consolidation. In general, you rehabilitate a defaulted government student loan by agreeing in writing to make regular monthly payments for a specified period of time. Depending on the program, these payments can be full monthly payments or reduced payments based on your income. After you rehabilitate your student loan, the default will be removed from your credit rating, but reported delinquencies will remain.
Loan consolidation allows you to pay off one or more government student loans by securing a new direct-consolidation loan. This loan has income-driven repayment plans and a fixed interest rate. To qualify, you must either agree to repay under one of the repayment plans or make three consecutive payments on time before consolidating. After consolidating, your new loan is once again eligible for deferment, forbearance and even loan forgiveness under certain circumstances. Consolidation will not remove the default event from your credit rating, however.
One of the benefits of taking out government student loans over using private student loans is that you have options available to you when you are having trouble making your student loan payments. Specifically, if you need help because of financial hardship or a lack of employment, you can apply for a deferment or forbearance on your student loan.
A deferment delays your repayment for a period of time. If you have a subsidized student loan, interest on the loan will not accrue during the deferment. If not, you can either pay the interest during the deferment or add it to the principal balance. Student loans can be deferred for up to three years for economic hardship or if you are unemployed or unable to find full-time employment. You also can get an indefinite deferral if you are in graduate school or in the military during a war or active military operation.
If you cannot make your student loan payments and do not qualify for a deferral, you can apply for forbearance. A forbearance can lower your payments or even allow you stop making payments for up to 12 months. You can qualify for a forbearance due to financial hardship or illness. Interest will continue to accrue during this time, even on subsidized government student loans. As with a deferral, you can either pay the interest or add it to the principal, which will increase your future payments.
Your final option for preventing default is to refinance your government student loan or loans through a private lender or a bank. Refinancing can be an especially good option if your credit rating is strong, and you have a steady income. A good credit rating can help you save money on your monthly payments or even pay less interest over the life of your loan, depending on the terms.
Watch out for hidden fees, however, and make sure you are working with a reputable lender. Many large banks and online lenders now offer student loan refinancing, so take your time, research your options and compare plans, terms and rates. If you are already in default or have been delinquent for more than 90 days, you may be better off pursuing some of the options mentioned earlier before turning to refinancing. If you can gain control of your payments through a deferral or forbearance and repair your credit through rehabilitation or consolidation, you will be able to secure better terms on an eventual refinance.