Default Rehabilition

If any of your federal student loans are in default, there are options. We’ll focus on helping to get you out of default through one of the following: loan rehabilitation or loan consolidation.

If you have private loans, know that most loan holders want to work with you to avoid default, or (if you're already in it) to help you recover. Contact them as soon as possible and explain your circumstances. You might be pleasantly surprised by what they offer.

Advantages

Getting out of default as fast as possible has four main benefits:

  1. No more wage garnishment or Treasury offset. While in default, collections agencies are often authorized to use various means to get money from you, including wage garnishment (automatically deducting payments from your paychecks) and Treasury offset (holding onto any money you receive from the Federal government, include tax refunds or social security checks). Getting out of default would end this.
  2. Use other federal loan benefits again. Once you're out of default, you can take advantage of deferment or forbearance when needed, and your payments can also start counting toward the public service loan forgiveness program.
  3. Lower collection fees. While in default, a fraction of any payments you make go to the collection agencies. Sometimes that fraction is as high as 30%. Getting out of default does incur fees, but once you're out you’ll no longer be paying the collection agencies out of your monthly payments.
  4. Repair credit. If you achieve loan rehabilitation, the derogatory mark on your credit history (from defaulting) will be removed. Note that this benefit applies to loan rehabilitation only, not loan consolidation. Unfortunately, even with loan rehabilitation, the negative marks to your credit from missing or late payments will still remain for up to 7 years; at which point, your credit will improve.

Drawbacks 

  1. It takes some time. Loan rehabilitation takes 9-10 months, and loan consolidation takes about 30 days. During that time, your loan will still be considered in default, so you may continue to receive communication from the collection agencies.
  2. Fees. With loan rehabilitation, you may have up to 16% of each payment you make during the rehabilitation period (9-10 months) added to your balance. With loan consolidation, it could be up to 18.5%, but paying now is much better than paying an additional 30% on each monthly payment moving forward.

Requirements

You can obtain loan rehabilitation for your direct loans or FFEL loans. To do so, you must contact your loan holder, who will determine the amount for you to pay during rehabilitation--typically this is about 15% of your discretionary income (your income minus $18,000/year). If you pay this amount for at least 9 out of the next 10 months, you’ll be out of default, and the default will be taken off your credit history. You can also obtain loan rehabilitation on Perkins loans, but the requirement is stricter by asking you to make the full monthly payment for the next 9 months in a row.

Note that, unfortunately, loan rehabilitation is a one-time only offer. If you use it, and then default again on that same loan, you won’t be able to rehabilitate again.

Loan consolidation works differently. You're essentially combining your defaulted loan with another loan, into a new “consolidated” loan that will now be current. You must meet all the following requirements:

  • Have at least one other federal loan to combine it with (unless the defaulted loan is FFEL, in which you're not required to combine it with another loan).
  • If your wages are being garnished, you first need that to be lifted.
  • You must agree to pay the new, consolidated loan, under an income-driven repayment plan. (Alternatively, you can make 3 full monthly payments in a row--though getting on an income-driven repayment plan is a great idea, so it is worth considering.)

Possible Next Steps

Loan rehabilitation is often the better option, so start with that if you're able to --- if you can pay 15% of your discretionary income for the next 9 months. To get into the rehabilitation program, contact your loan holder. Note that this is not your loan servicer; the loan holder is the one who actually owns your debt. You can log into the FSA site (studentaid.gov) to check who that is, then look them up to see what number to call or whom to contact.

If you can’t do loan rehabilitation, and you have at least one other loan to combine the defaulted loan with, you can apply for loan consolidation.

If you aren’t able to use either of these options, unfortunately, that means you’ll need to repay the loan amount in full in order to get out of default.

Most people find themselves eligible for at least one of these two programs, so you have options to get back on track. Getting out of default is the first step, and then you can look into all the other options that will make repayment much easier: income-driven repayment, deferment and forbearance, and public service loan forgiveness.

Summary

  • If you don’t meet your monthly payments for a while, your loan will go into default. That means a collection agency will be engaged to get money from you, possibly through wage garnishment.
  • With federal loans, there are two options for getting out of default, besides paying the entire loan balance immediately: loan rehabilitation and loan consolidation. Once you're out of default, you can take advantage of the benefits of federal loans, including income-driven repayment, to get back on track.
  • Loan rehabilitation takes 9-10 months. You must contact your loan holder, and agree to pay the amount they select (which is usually 15% of your income minus $18,000) for the next 9 out of 10 months. Once rehabilitated, the default will be removed from your credit history --- though the marks from previous late or missed payments will remain.
  • Loan consolidation takes about 30 days. You must combine your defaulted loan with another federal loan, and agree to get on an income-driven repayment plan.

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