If your federal student loans are in default, you can get them back into good standing without much pain and suffering.
There are three ways to get your loans out of default.
- Pay in full (don’t worry: 99% of people can’t do this)
Each method has advantages and disadvantages.
Pay In Full
Once your student loan defaults, the entire balance comes due at once. Not many of us can write a check for tens of thousands of dollars, but paying whatever you can helps.
Cost: Collection costs of up to 25% of your loan balance will be applied 120 days after the default, so lowering that balance as much as you can will make a difference.
To rehabilitate your loans, you need to make nine on-time monthly payments to your loan holder. You and the loan holder (or the collection agency working with the loan holder) will agree on a reasonable and affordable payment amount for these.
All nine payments must be consecutive, on time (within 20 days of the due date), and voluntary to count toward rehabilitation. If your wages are being garnished, you will have to make these voluntary payments in addition to the garnishment. Once you make the first five payments, the garnishment order will be suspended. You may only receive this suspension once, so it’s important to keep making your rehabilitation payments on time.
How Much Will Your Payment Be?
Your loan holder will initially calculate your rehab payments as 15% of your disposable income (which is your adjusted gross income minus 150% of the poverty level for your family size). To do this, they will need information about your income, as well as the number of people in your family. You can provide these details verbally over the phone; however, if you agree to this payment amount, you must submit proof that your income is what you said it was.
If you can’t afford that amount, your loan holder will ask for more information about your expenses via this federal form to better understand your total financial circumstances. This often, but not always, results in a lower payment. You can then choose between the 15% formula amount and the amount based off the more detailed information. If neither is acceptable, you may not be able to participate in the rehabilitation program.
What Happens After Rehabilitation?
Once you have agreed upon a payment amount and made all the payments, your loan is considered rehabilitated (yay!) and your loan will be sent to a new lender and servicer. You will send all future payments to this new loan servicer, so make sure you have their payment address and contact information.
You’ll also need to work with them to develop a new payment plan that will allow you to keep your loan in good standing, as loans rehabilitated on or after August 14, 2008, can only receive the rehabilitation opportunity once. Rehabilitated loans are eligible for lower payment options, such as income-based repayment and extended repayment.
Not only will rehabilitation get your loans back on track, but it may also help your credit and lower your collection costs. And, if you are going back to school, you typically become eligible for additional financial aid once you’re six payments into the rehabilitation process.
To get started, contact your loan holder, which will be either your guarantor or the Department of Education. You can find out who this is on the National Student Loan Data System (NSLDS®).
Cost: Collection costs will be charged of up to 16% of the total unpaid amount, which includes interest.
Advantage: Once your loans are rehabilitated, the default will be removed from your credit history (though the delinquency will stay).
Disadvantage: Time. This takes 9 months. If you are looking to go back to school soon and need financial aid, this could delay your educational goals.
Consolidating out of default is a faster way to get out of default than rehabilitation, but it doesn’t have the same advantages.
You can consolidate your loans out of default by doing either of the following:
- Arranging three consecutive payments with your current loan holder and then consolidating into the Direct Loan program (the only place where you can consolidate federal student loans).
- Agreeing to repay a consolidation loan under income-based repayment or income-contingent repayment with Direct loans.
This means that you can have your loans out of default in 3 months or less! Just keep in mind that consolidation can make your loan more expensive by extending how long you repay the loan. You can learn all about the general pros and cons of consolidation here.
Cost: Collection costs will be charged of up to 18.5% of the total unpaid amount, which includes interest.
Advantage: Time. This can be done faster than rehabilitation.
Disadvantage: Consolidation does not remove the default from your credit report and can cost you more money over the lifetime of your loan.
There really isn't a right or wrong choice here. Whichever method you choose should be the one that works best for you.
To Get Started
To get started, contact your loan holder. If you aren't sure who that is, you can look it up in NSLDS.