If you’re struggling to make payments on your federal student loans, the last thing you want is to default. At that point, the U.S. Department of Education can refer your account to a debt collection agency.

Not only can the process damage your credit, but you’ll also be on the hook for the cost of collection charges on your own debt.

What Are Student Loan Collection Charges?

If your federal student loan payments are past due, the U.S. Department of Education will give you several chances to get caught up on your student loan payments before referring your account to a debt collection agency.

The U.S. Department of Education pays the collection agency a commission, also called a contingent fee, on any payments it can collect from you. But here’s the kicker: you, as the borrower, cover the cost of that commission.

Collection charges for defaulted federal student loan debt can add up to 25% more than the principal and interest you repay through the collection agency. The collection charges are based on the average cost of collection, as opposed to the actual cost of collection your defaulted loans. (Collection charges on defaulted Federal Perkins Loans can be higher.) 

You’ll typically pay the collection charges as part of your monthly payment. In fact, your payments to the collection agency are first applied to cover collection charges then interest and principal after that. (The payment application order for income-driven repayment plans is different, with payments applied first to interest and then to collection charges, instead of vice versa.) As much as a fifth of every payment will be applied to collection charges.

If you choose to pay the debt in full, you’ll get an estimate on each billing statement from the U.S. Department of Education showing what you’d need to pay to satisfy the debt, including collection costs.

How to Avoid or Reduce Collection Charges

Depending on how much student loan debt you have, you could owe thousands of dollars in collection charges. If you’re already in default, here are a couple of things you can do to get them waived or reduce how much you pay.

Settle Your Debt

The U.S. Department of Education allows student loan debt collection agencies to offer three settlement options to defaulted borrowers. One of those options involves waiving the collection charges on your loans.

The catch is that you have to pay a lump sum for the full settlement amount, typically within 90 days, to qualify. If you don’t, you may lose the offer, and you’ll go back to paying the full amount with the collection fees attached.

Rehabilitate Your Defaulted Loans

If you can’t afford to settle your debt, you can reduce how much you pay in collection charges by rehabilitating your loans with the U.S. Department of Education.

To start the process, contact your loan servicer. You’ll need to agree in writing to make nine voluntary, reasonable and affordable monthly payments — involuntary payments made through wage garnishment or an offset of your tax refund don’t count — within 20 days of the due date. Then you’ll need to make those nine payments during a period of 10 consecutive months.

If you start the rehabilitation process within 60 days of default, no collection fees will be added to your loan or monthly payments.

If you don’t rehabilitate during this grace period, the nine payments will include collection fees of roughly 20%, with the rest going to principal and interest. Once you complete the process, though, you’ll no longer be on the hook for collection charges.

Consolidate Your Defaulted Loans

Another way to get out of default is to consolidate your loans with a new servicer with a Federal Direct Consolidation Loan. To do this, you’ll need to either make three consecutive, voluntary, on-time and full monthly payments on the defaulted loans before submitting your request or agree to repay the new loan under an income-driven repayment plan.

If you make the three necessary payments before consolidating, your collection charges will be reduced to 2.8% of the principal and interest amount. If you opt to get on an income-driven repayment plan instead, the collection fee will be $150 or 16% (previously 18.5%), whichever is less. Either way, the charges will be included in your new loan amount.

Weigh Your Options

The idea of paying thousands of dollars in collection fees can be daunting, so it’s good news that you don’t have to. By settling your debt with the debt collection agency or rehabilitating or consolidating your defaulted loans, you can reduce your collection charges or get them waived entirely.

Take the time to consider your options, then choose the one that’s feasible for your situation and will save you the most money.

Of course, it is always better to avoid defaulting on your federal student loans. Talk to the loan servicer about your options before defaulting on your loans. Depending on the nature of your financial difficulty, the best options include deferments, forbearances and income-driven repayment.