Nearly 40% of student loan borrowers are either in default or more than 90 days past-due on their payments.
While the amount owed per student has increased significantly in recent years – a key contributor to the higher rates of default – so have the repayment options to avoid default. Understanding the consequences of defaulting and the range of options available to prevent it happening are crucial.
This article discusses default of federal and private student loans and how to avoid it.
What do we mean by default?
The first step on the road to default is becoming delinquent on your student loan debt. The loan becomes delinquent the first day after you miss a scheduled payment. Even if you miss just one monthly payment and then start making payments again, your loan account will remain delinquent until you repay the past due amount or make other arrangements, such as deferment or forbearance, or change repayment plans.
Default occurs when you remain in delinquency for a set period of time. The point when a loan is considered to be in default varies depending on the type of loan you have. You will be considered to be in default if you don’t make your scheduled federal student loan payments for a period of at least 270 days. For a loan made under the Federal Perkins Loan Program, the holder of the loan can actually declare the loan to be in default if you don’t make any scheduled payment by the due date.
For private loans, the time period is typically just 120 days, but different lenders may have a different time-frame depending on their loan contracts. However, some private lenders will consider you to be in default as soon as you miss a payment.
Consequences of defaulting
The consequences for defaulting on your federal or private student loan debt can be severe. Consequences can include:
- Your wages may be garnished (up to 15% for federal loans and the lesser of 25% of your disposable income or all income which exceeds 30 times the Federal minimum wage for private loans).
- You can be sued by the lender for the full amount owed.
- You may be charged court costs and collection fees.
- Your tax refunds and federal benefit payments may be withheld and applied toward repayment of your defaulted loan.
- Long-term damage to your credit score making it significantly harder access auto, home and other loans at accessible rates, if at all.
- You can no longer receive deferment or forbearance, and you lose eligibility for other benefits, such as the ability to choose a repayment plan.
- You will lose eligibility for additional federal student aid.
- You can have your academic transcript withheld by your school
- You can potentially have the renewal of a professional license blocked.
How to avoid defaulting
Default is clearly a worst case scenario and there are potentially several steps you can take to prevent it. Your options will vary based on the type of loans you have as well as your personal financial circumstances.
It goes without saying that if you are concerned that your student loan burden is becoming unmanageable then the first thing you should do is speak to your lender as soon as possible. You shouldn’t wait until you go into delinquency or default to make contact. Your lender will be able to run through the financial hardship options they offer (eg. forbearance). If you contact your lender and explain your situation they may be able to offer you some student relief options.
We will discuss what steps you can take if you find yourself in one of the following common scenarios:
- Financial hardship
- Financial strain
Scenario one: financial hardship
Due to certain life circumstances you might find that you do not currently have an income from which to make payments towards your student debt. For example, you might be suffering a financial hardship such as having been made unemployed and facing limited job prospects or you might be dealing with a serious medical issue. In these situations, you are likely to want to apply for deferment or forbearance.
Apply for deferment or forbearance
Provided you meet certain eligibility requirements, deferment or forbearance allows you to temporarily suspend making payments for a specified period. The main difference is that with a deferment, you may not be responsible for paying the interest that accrues on certain types of loans during the deferment period. However, during forbearance you are responsible for paying the interest that accrues on all types of federal student loans. Federal student loans provide up to 3 years of deferment and forbearance benefits.
|You are not responsible for paying the interest that accrues on the following loan types during deferment:||You are responsible for paying all interest that accrues on the following loan types during deferment:|
|Direct Subsidized Loans||Direct Unsubsidized Loans|
|Subsidized Federal Stafford Loans||Unsubsidized Federal Stafford Loans|
|Federal Perkins Loans||Direct PLUS Loans|
|The subsidized portion of Direct Consolidation Loans||FFEL PLUS Loans|
|The subsidized portion of FFEL Consolidation Loans||The unsubsidized portion of Direct Consolidation Loans|
|The unsubsidized portion of FFEL Consolidation Loans|
Eligibility for either deferment or forbearance varies. The table below summarizes the key qualifications for each option:
|Deferment of federal student loans||Forbearance for federal student loans||Deferment and forbearance for private loans|
|Unemployed||In a medical/dental internship or residency||Private lenders are not compelled to grant you deferment or forbearance. When available, the terms on offer will vary by lender.|
|In school (at least part-time)||Active in the National Guard|
|Receiving state or federal assistance||In the process of qualifying for Teacher Loan Forgiveness|
|In the process of qualifying for Perkins loan cancellation||Sickness (subject to lenders approval)|
|On active military duty or the Peace Corps|
|Earning a monthly income of less than 150% of your state’s poverty line|
Scenario two: financial strain
In this scenario you are employed and can continue to make payments towards your student debt, though either a low salary or high costs (or a combination of the two) make it difficult for you to make the full monthly payment. This is often the case faced by recent graduates who are in entry salary position. In this scenario, you are likely to have a few options available to you:
Federal debt repayment
Income-driven repayment plans can be a great option if you are earning a salary but are still concerned about defaulting on your federal student debt. An income-driven repayment plan sets your monthly student loan payment at an amount that is intended to be affordable based on your income.
There are four income-driven repayment plans available for federal loans:
- Pay As You Earn Repayment Plan (PAYE Plan)
- Revised Pay As You Earn Repayment Plan (REPAYE Plan)
- Income-Based Repayment Plan (IBR Plan)
- Income-Contingent Repayment Plan (ICR Plan)
The four repayment plans all have their own requirements in terms of who qualifies, how much you have to pay each month, the length of the repayment period, the types of loans that can be repaid under the plan as well as the pros and cons associated with each.
These plans allow you to qualify for student loan forgiveness after a specified amount of payments, which vary by plan.
Federal loan consolidation
One option is to have your federal student loans consolidated with a Direct Consolidation Loan. A Direct Consolidation Loan allows you to combine all your federal education loans into one loan. The result is a single monthly payment based on a fixed interest rate instead of multiple payments. Consolidation can lower your monthly payments by giving you a longer period of time (up to 30 years) to repay your loans. Loan consolidation can also give you access to additional loan repayment plans and forgiveness programs.
However, loan consolidation also has its downsides. Most notably, because consolidation increases the period of time you to have to repay your loans, you might make more payments and pay more in interest over the life of the loan. Loan consolidation is generally not available for private loans.
Refinancing allows you to combine all your loans into a single new loan with new terms. Refinancing can simplify your monthly payments while also making them more manageable by lowering your interest rate.
Refinancing is generally not preferable if you have federal student debt. With refinancing you can lose access to federal forbearance and deferment, income-driven repayment plans, and federal student loan forgiveness programs.