Student loan debt is a huge issue in the U.S. and continues to get worse. In fact, nearly 70% of the class of 2015 graduating from public colleges walked away with student loans averaging more than $30,000. That’s a 4% increase from just the previous year. And while unemployment and underemployment rates for entry-level college graduates have begun to decrease since the beginning of the Great Recession, they’re still both higher than pre-recession levels.
This essentially means that students are paying more for their college education today than ever before, yet not always seeing it translate into better jobs and pay. So it should come as no surprise that defaulting on student debt is becoming more and more common. However, like any type of loan default, it has huge implications on an individual’s credit score and future ability to borrow. Plus, student loan defaults come with different consequences than other types of loan defaults. If you’re in default on your loan, or close to it, read on to find out exactly what that means and what steps you can take to help your specific situation.
When Am I Considered in Default on a Student Loan?
As soon as you miss a payment even by a day, your student loan is considered delinquent. Your loan servicer may report any late payments to all three credit bureaus after your payment is 90 days late or more. If you are on a monthly installment plan and your late payment reaches 270 days, your loan goes from being delinquent to being in default. Less frequent installments may allow you to go up to 330 days of missing a payment before being considered in default. As soon as you know you won’t be able to meet your financial obligations, start exploring your options to get help. The sooner you reach out, the more options you’ll have available to you.
What Happens During Student Loan Default?
Once the delinquency period has passed and your loan is placed in default, several ramifications go into effect. One of the most immediate consequences is that you’ll lose any eligibility to qualify for forgiveness plans. If you have federal student loans, you may have access to get help through the form of forbearance, deferment, and income-based repayment options. But you lose eligibility for those programs as soon as you leave the delinquency period and settle into default. That’s why it’s so important to reach out for help early on in the process.
Your credit score will also be affected the longer your student loan goes unpaid. Delinquencies are noted on your credit report in 30-day increments and each time you bump up to a longer period of non-payment, your credit score drops. And it’ll go even lower when you enter into default. Why is your credit score important? Because it determines whether or not you’ll qualify for future loans and credit cards, in addition to how much interest you’ll have to pay if you do qualify. This affects you whether you want a new credit card, a car loan, a mortgage, or even a personal loan.
If that sounds bad, things can get even more serious when your student loan goes into default. Typically, your debt is turned over to a collection agency who may attempt to collect the entire balance of the loan in a single payment. They might also take steps to recover the money you owe by offsetting your federal and state tax refunds. They can also assign your loan to a more costly private collection agency, or begin wage garnishment action to take as much as 15% of your disposable income. Even more unsettling is that once you hit default status, the federal government can sue you at any point.
What Steps Can I Take To Prevent Student Loan Default?
After graduating or leaving school, it’s time to get started on those loan payments. Some student loans offer grace periods lasting either six or nine months, but don’t just assume you have one. Check your loan agreement to understand your exact terms, particularly if you took out loans from a private lender. Once your repayment period begins, your lender will notify you by mail.
The best way to prevent default is to keep up with payments. If you can’t do this for some reason, you have several options to consider. For federal student loans, there are a few different programs available. Depending on your loan type and balance, you may be able to change your repayment terms to lower your monthly payment amount. Many of the plans have broad eligibility requirements so you may find success with one of these. Just note that you should only alter your repayment structure if you’re experiencing major financial hardship. These plans tend to cost you more money in the long run since they often require extending your repayment term.
Another option with a federal student loan is to apply for an income-driven repayment plan. There are different programs suited for various situations, but each one uses your current income as a barometer to lower your payments. Your payment amount then increase over the years as you grow in your career and (most likely) earn more. Finally, you can apply for deferment or forbearance on your federal student loan. Deferment refers to a temporary delay on paying both your loan’s principal and interest. You don’t have to make any payments during this time, and in some instances, the government may even make your interest payments for you.
If you don’t qualify for a deferment, you could still be eligible for a loan forbearance. This involves either suspending or lowering your monthly payments for up to 12 months. Interest still accrues during the forbearance period, but it prevents the loan from going into default and gives you a chance to catch up on your finances before you start making payments again.
While federal student loans generally have the most options for helping borrowers through tough times, you can still ask for help if you’re working with a private lender. First look into refinancing to a lower interest rate. You’ll need good credit but this is a low-cost way get your monthly payments down. If you don’t qualify to refinance, call your lender directly and see if there are any other options available. Explain why you are at risk of falling behind on your payments and you may be able to renegotiate the current terms of your loan agreement.
Can My Defaulted Student Loans Be Cancelled or Discharged?
According to the Higher Education Act, loans can only be canceled if you die or become “totally and permanently disabled after the loan is disbursed.” Loans can also be discharged, outside of bankruptcy proceedings, if your school improperly certified the training it offered, closed while you were in attendance, or closed within 90 days after you withdrew. These are fairly rare situations though, so let’s take a look at happens more frequently.
If you are looking to declare bankruptcy as a solution, it can sometimes offer the relief you need; however, discharging student loans under Chapter 7 is unlikely in most cases because student loans are specifically excluded from discharge in the bankruptcy code. The non-discharge-ability requirements for educational loans are for both student borrowers and parent borrowers, and they also apply to consolidation plans.
But getting around this law requires petitioning for “undue hardship,” which is only granted in extremely special circumstances. You typically must prove to the court that you are unable to pay now and have no chance of being able to pay the loan in the future. However, you shouldn’t rely on any type of bankruptcy to get out of your student loans because it is very difficult to do. Then you’ll still end up owing your student loans just as you did before filing for Chapter 7 bankruptcy.
Under Chapter 13, you have the chance to at least get a break from high student loan payments. This type of bankruptcy has a higher income threshold compared to Chapter 7 and entails signing up for a repayment plan for a predetermined period of time. Your monthly repayment amount is based on your income and expenses and is divvied up amongst your creditors. In this situation, student loans are considered nonpriority unsecured debts, similar to credit card and medical debt. While this won’t cancel out your student debt, it can help lower your monthly payment obligation during the bankruptcy period. Just note that interest continues to accrue at its typical rate and you’ll have to continue your regular payments once your bankruptcy period is over.
Who Can I Talk to for More Information?
The U.S. Department of Education has a toll free customer service line with agents who can provide more information about both federal loan repayment and loan discharge-ability: 1-800-621-3115. If you have private student loans, call your lender directly to discuss your options to avoid default. If you’re struggling with various types of financial debt, consider contacting a local bankruptcy lawyer to help you find the best path for your financial situation.