Rehabilitation of Defaulted Federal Student Loans

If you’re in default with one or more of your federal student loans, you’re not alone. In the last few years, about 10% to 15% of borrowers have defaulted within three years of entering repayment. According to a recent report by the Urban Institute, 22% of student loan borrowers eventually fall into default. 

With student loan defaults on the rise, it’s more important than ever to have a plan to pay down your debt. If you do go into default, though, there is a way out called rehabilitation.

The sooner you learn about how rehabilitation works and start the process, the more time and money you’ll save.

What Happens When You Default on Your Student Loans

With Federal Direct Loans and Federal Family Education Loans, default happens after you’ve gone 270 days, or about nine months, without making a payment. With private student loans, on the other hand, default can happen after 120 days of non-payment.

If your federal loans go into default, the consequences can make repaying your debt even more difficult. For starters, the entire balance will become due immediately. Also, the U.S. Department of Education will hire a debt collection agency, which can tack on collection charges of up to 25% of your combined principal and interest. (They can be even higher on Federal Perkins Loans.)

Other consequences include:

• You lose access to deferment and forbearance.
• You’ll no longer be able to choose your repayment plan.
• Your wages and Social Security benefits may be garnished.
• Your income tax refunds and state lottery winnings may be withheld for payment.
• You’ll no longer be eligible for additional financial aid.
• The default will be reported to the credit reporting agencies, which can damage your credit score. This can affect your ability to qualify for credit cards, auto loans and mortgages, and you may be charged a much higher interest rate.
• Your loan servicer can take you to court.

All of these things combined can make a financial hardship much worse. Fortunately, the U.S. Department of Education makes it possible to get your loans out of default and escape some of the consequences.

How to Rehabilitate Defaulted Federal Loans

Rehabilitating your defaulted student loans not only removes the default status, but it also stops wage garnishments and tax refund withholdings and removes the default from your credit report. (Although, late payments will still show up on your credit history.)

What’s more, access to federal loan benefits like deferment, forbearance, income-driven repayment plans and loan forgiveness will be restored. Also, if you start the rehabilitation process within 60 days of default, you won’t be on the hook for collection charges.

If you don’t rehabilitate during the initial 60 days, your rehabilitation payments will include collection charges of about 20% of the payment amount, but they’ll go away after you complete the process.

The rehabilitation process can vary depending on the type of loans you have. For Federal Direct Loans and Federal Family Education Loans, you’ll need to agree in writing that you’ll make nine voluntary, reasonable and affordable monthly payments within 20 days of the due date. Then you’ll need to make all nine of those payments during a period of 10 consecutive months.

Your loan servicer will determine the payment amount, but depending on your income situation, they may be lower than your original payment amount. Also, note that wage garnishments and tax refund withholdings don’t count as voluntary payments.

Consolidation Can Also Help Get Loans Out of Default

Another way to take your loans out of default is to consolidate them with a Federal Direct Consolidation Loan. The process is easier but also more expensive. Also, consolidation isn’t an option if you’re repaying your defaulted loans through wage garnishments or in compliance with a court order.

If you do qualify to consolidate your defaulted loans, you’ll need to do one of two things:

• Make three consecutive, voluntary, on-time and full monthly payments on the defaulted loans before applying to consolidate.
• Agree to repay the new consolidation loan under an income-driven repayment plan.

If you choose the first option, your collection charges will be 2.8% of the principal and interest amount. While that’s low, it could still be hundreds or even thousands of dollars. If you choose to get on an income-driven repayment plan, your collection charge will be the lesser of 16% or $150. The collection charges are added to the consolidation loan balance.

Next Steps

If your loans aren’t yet in default, work with your loan servicer to prevent it from happening. If that opportunity is past, contact your loan servicer or collection agency to talk about rehabilitating your loans. You can also call the Default Resolution Group at the U.S. Department of Education at 1-800-621-3115 (TTY 1-877-825-9923).

If the rehabilitation plan your loan servicer lays out sounds too difficult, consider consolidating as an alternative. Regardless of which option you choose, your debt won’t go away, and you may still have years of payments to go. But getting your federal student loans out of default can save you a lot of money and stress.

Note that rehabilitation is a one-time opportunity to clear the default. If you default again, you will not be able to rehabilitate your federal student loans a second time.