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Defaulting on Student Loans

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This section of FinAid provides information to students who are thinking about defaulting on their federal education loans. It summarizes the consequences of default, gives advice on how to avoid it and, if you're already in default, how to get out of it. See also Trouble Repaying Debt. A separate page discusses how to settle defaulted federal student loans for less than what you owe.

You are responsible for repaying your student loans even if you do not graduate, have trouble finding a job after graduation, or just didn't like your school. If you do not make any payments on your federal student loans for 270-360 days and do not make special arrangements with your lender to get a deferment or forbearance, your loans will be in default. Defaulting on your student loans has serious consequences.

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Note that student loans are now generally not dischargeable through bankruptcy. It is fairly difficult to satisfy the requirements for an undue hardship petition, which generally requires demonstrating that you made a good faith effort to repay the debt, that you will not be able to maintain a minimal standard of living and still repay the debt (usually using the lowest monthly payment under any of the repayment plans, typically income-contiengent or income-based repayment), and that the conditions that prevent you from repaying the debt will likely persist for most of the full term of the loan. Even if you satisfy the requirements of an undue hardship discharge, often this will result in just a partial discharge of the debt.

Almost three-quarters of students who default on their loans have done so after withdrawing from school and failing to complete their studies.

Federal Guide to Defaulted Student Loans

The US Department of Education Debt Collection Service publishes a guide called Guide to Defaulted Student Loans to help students repay their defaulted student loans. It includes information about repaying a defaulted student loan, loan consolidation, the consequences of default, collection costs, resolving disputes, ineligibility for further Federal student aid, and related topics. For more information on repaying a defaulted loan, call 1-800-4-FED-AID (1-800-433-3243) or 1-800-621-3115.

Other helpful web sites include:

Consequences of Default

If you default on your student loan:

  • Your loans may be turned over to a collection agency.
  • You'll be liable for the costs associated with collecting your loan, including court costs and attorney fees.
  • You can be sued for the entire amount of your loan.
  • Your wages may be garnished. (Federal law limits the amount that may be garnished to 15% of the borrower's take-home or 'disposable' pay. This is the amount of income left after deducting any amounts required by law to be deducted. The wage garnishment amount is also subject to a ceiling that requires the borrower to be left with weekly earnings after the garnishment of at least 30 times the Federal minimum wage, per 34 CFR 682.410(b)(9), 34 CFR 34.19(b) and 15 USC 1673(a)(2).)
  • Your federal and state income tax refunds may be intercepted.
  • The federal government may withhold part of your Social Security benefit payments. (The US Supreme Court upheld the government's ability to collect defaulted student loans in this manner without a statute of limitations in Lockhart v US (04-881, December 2005).)
  • Your defaulted loans will appear on your credit history for up to 7 years after the default claim is paid, making it difficult for you to obtain an auto loan, mortgage, or even credit cards. A bad credit record can also harm your ability to find a job. The US Department of Education reports defaulted loans to TransUnion, Equifax and Experian.
  • You won't receive any more federal financial aid until you repay the loan in full or make arrangements to repay what you already owe and make at least six consecutive, on-time, monthly payments. (You will also be ineligible for assistance under most federal benefit programs.)
  • You'll be ineligible for deferments.
  • Subsidized interest benefits will be denied.
  • You may not be able to renew a professional license you hold.
  • You may be prohibited from enlisting in the Armed Forces.

And of course, you will still owe the full amount of your loan.

See The Horrors of Defaulting on Education Debt for a discussion of some of the more horrific consequences of defaulting on student loans.

Preventing Default

  1. Borrow as little as possible. Default rates increase with overborrowing. If your total debt will be more than twice your expected starting salary, you are borrowing too much and should consider attending a less expensive college. Live like a student while you are in school so you don't have to live like a student after you graduate.

  2. Make sure you understand your options and responsibilities before taking out a loan.

  3. Prepare a checklist of all your loans, including the name and phone number of the lender, the type of loan, the amount of the loan, the interest rate, and especially any due dates or deadlines.

  4. Make your payments on time.

  5. Notify your lender or servicer promptly of any changes that may affect the repayment of your loan. If you move or change your address, let them know. Likewise tell them about name changes (e.g., because of marriage), graduation or termination of studies, leaves of absence and transfers to another school.

  6. If you encounter temporary financial difficulties, consider applying for a deferment or forbearance on your loans. It is better to defer your payments than to go into default. Ask your lender about these options while you are still making payments, before you default on your loan. You won't be able to get a deferment or forbearance after you default.

    Send in your deferment form by certified mail, return receipt requested, so you have proof it was submitted. Continue making the monthly payments until the lender notifies you that your deferment has been approved. Some deferments are not automatic. If you stop making payments before approval, your loan could go into default. This would prevent the lender from approving the deferment. Do not make any assumptions. If you haven't heard from the lender in a month, call them, and keep on calling them.

  7. If you are having trouble making payments due to a more permanent income deficit, your lender may be able to suggest alternate repayment options, such as extended repayment, graduated repayment, income sensitive repayment, income contingent repayment and income-based repayment. Income-based repayment will typically have the lowest monthly payment. The types of available repayment options currently depend on whether the loan was issued under the FFELP or FDSLP (Direct) programs.

    All of the alternate repayment plans reduce the monthly payment by increasing the loan term. This will increase the total interest paid over the life of the loan. For example, increasing the loan term from 10 to 20 years on a Stafford loan will cut the monthly payment by about a third, but will more than double the interest paid over the life of the loan.

    Some students who have both federal and private student loans will use an alternate repayment plan on the federal loans, to reduce the monthly payment on the federal loans, and use the savings to pay off the more expensive private student loans quicker. While this is generally good advice, only pursue this option if you are sure you can resist the temptation to spend the savings. Any savings must be used to pay down debt.

  8. Consider using a consolidation loan to combine all of your educational loans into one big loan. This lets you send your payments to just one lender. You may also be able to extend the term of the loan in order to reduce the size of your monthly payments.

  9. Keep careful records regarding your loan. Put copies of all your letters, canceled checks, promissory notes, notices of disbursement and other forms in a file folder. Record your payments and the date you mailed or made the payment in a spreadsheet or a personal finance program like Quicken or Microsoft Money.

  10. If you have both federal and private education loans and can afford to make the required payments on only one loan, try to avoid defaulting on the federal loans. The federal loans have more flexible repayment options and harsher penalties for default.
Postponing Repayment

Two options available for postponing repayment of your student loans are deferments and forbearances. If you are thinking about defaulting on your student loans, ask the lender whether you are eligible for a deferment or forbearance before you default. You cannot receive a deferment or forbearance if your loan is in default. If you default on your loans, you are no longer eligible for deferments and forbearances.

For more information about deferments and forbearances, contact the financial aid office at the school that issued the loan and/or the original lender or current servicer of your loan.

Deferments

During deferment, the lender allows you to postpone repaying the principal of your loan for a specific period of time.

Most federal loan programs allow students to defer their loans while they are in school at least half time. For Perkins Loans and Subsidized Stafford Loans, no interest accrues during the deferment period because the federal government pays the interest. For other loan programs, such as the unsubsidized Stafford loan, the interest still accrues during the deferment period. Students can postpone the interest payments on such loans by capitalizing the interest, which increases the size of the loan. (Capitalizing the interest adds it to the loan principle. This increases the amount of the debt, which means you'll be paying interest on interest, in addition to interest on the principal.)

Deferments are commonly granted for

These deferments are for the FFELP and FDSLP loans, not the Perkins loan. Other deferments may also be available; contact your lender for details. Note also that there are limits on the length of a deferment.

Deferments are not granted automatically. You must submit an application and provide documentation to support your request for a deferment. Do not stop making payments on your student loans until after you are notified that your deferment has been granted.

Forbearances

During forbearance, the lender allows you to postpone or reduce your payments, but the interest charges continue to accrue. The federal government does not pay the interest charges on the loan during the forbearance period. You must continue paying the interest charges during the forbearance period.

Note also that there are limits on the length of forbearance. Forbearances are typically granted in 12-month intervals for up to three years.

Forbearances are not granted automatically. You must submit an application and provide documentation to support your request for a deferment. Forbearances are granted at the lender's discretion, usually in cases of extreme financial hardship or other unusual circumstances when the borrower does not qualify for a deferment. Do not stop making payments on your student loans until after you are notified that your forbearance has been granted.

Getting Out of Default

To get out of default, you need to make arrangements with your servicer or lender to repay the loan. Once you have made six consecutive full voluntary on-time payments, you will be eligible for additional Title IV aid. On-time is defined as within 15 days of the due date. Voluntary excludes payments made by garnishment or other offsets. After you have made 9 of 10 consecutive payments within 20 days of the due date and applied for and received "rehabilitation", you will no longer be considered in default. At this time record of the default will be removed from the reports to credit reporting bureaus.

For loan rehabilitation, the payments must be "reasonable and affordable". This is determined by the guarantee agency, and will consider the borrower's (and his/her spouse's) disposable income and financial circumstances. It can be below the required minimum payment of $50 or the interest that accrues, whichever is greater, if the guarantee agency determines that a smaller amount is reasonable and affordable based on the borrower's financial circumstances.

Also, if you are seeking rehabilitation and your wages are subject to a garnishment order, sometimes the guarantee agency will be willing to accept the higher of the rehabilitation amount or the wage garnishment, as opposed to the sum.

Also, if the default is very recent, the lender may not yet have reported the default to a guarantee agency. Lenders do not need to file a default claim until 90 days after the default occurs. If the borrower brings the delinquency under 270 days (the definition of default for federal education loans) within the 90-day period, before the lender has filed a default claim, they can cure the default.

It may also be possible to cure the default by consolidating the delinquent loan before the lender has filed for a default claim. Since the consolidation loan is a new loan and it pays off the deliquent loans, it effectively wipes the slate clean.

While lenders have very powerful options for collecting defaulted debt, and so don't need to negotiate, they will often prefer to get the borrower into a voluntary payment plan than have to take the borrower to court. A good rule of thumb is a payment plan where you pay about 1% of the total amount owed per month.

For information about your options, contact the servicer of the loan and/or the original lender or the current holder of the loan. The financial aid office at your school should be able to tell you the name, address and telephone number of your lender and can also provide you with help and advice about repayment problems. You can also talk to the Default Resolution Group at the US Department of Education by calling 1-800-621-3115.

See also the chart listing options for relief.

Collection Agencies

If you default on your student loans, the lender or guarantor may use a collection agency to collect the loan. The collection agency's costs are added to the amount due, and the borrower is required to repay them in addition to the amount due on the loan.

Federal regulations state that a borrower who has defaulted on his or her student loans may be required to pay reasonable collection costs in addition to other charges, such as late payment fees. What constitutes reasonable is not very well defined.

Federal regulations concerning campus-based loan programs, such as the Perkins Loan, suggest that collection costs may not reasonably exceed 30% of the principal, interest and late charges collected on the loan, plus any court costs, for first collection efforts. For second collection efforts, the percentage increases to 40%. For Perkins loans made from 1981 through 1986, many promissory notes limited collection costs to 25% of the outstanding principal and interest due on the loan. Since then, however, promissory notes have had no such restriction.

For loans held by the US Department of Education (e.g., Federal Direct Stafford Loans), the department assesses collection costs at a rate of 25% of the outstanding principal and interest due on the loan (or 20% of the payment). FFELP lenders are limited to a similar amount. For an analysis of the impact of these collection costs, see FinAid's Loan Default Calculator and Collection Cost Impact Chart.

When consolidating a defaulted loan, collection costs of up to 18.5% of the outstanding principal and interest may be included in the amount consolidated. So a collection agency might be willing to reduce its fees to 18.5% if the student consolidates his or her loans. But the collection agency is under no obligation to do so. So if the student consolidates his or her loans and the collection agency does not reduce its fees, the student must pay the amount in excess of 18.5%.

If you work out a payment schedule within 60 days of default, some collection agencies will waive or reduce the collection fee.

Overall, it appears that collection costs can legally be as high as 40%, perhaps even higher.

If you think the collection costs are excessive, you can ask the collection agency to provide a detailed itemization of the actual costs incurred in collecting the loan. Although federal regulations are murky on this point, it appears that the costs must be based on either the actual costs incurred in collecting the loan or the average costs incurred for similar actions taken to collect loans in similar stages of delinquency.

While the federal government and state guarantee agencies are exempt from the Fair Debt Collection Practices Act (PDF) (see also other FTC links about FDCPA and the Fair Debt Collection Fact Sheet), the for-profit collection agencies they hire are not and must comply with the law. So be aware of the legal and illegal debt collection practices and your rights under the law. In particular, you may be able to stop the phone calls and letters by writing a letter to the collection agency and telling them to stop contacting you. The collection agency may then only contact you to tell you about specific actions they are taking, such as garnisheeing your wages. Note that you are still obligated to repay the debt even if the collection agency stops contacting you about it. In particular, interest will continue to accrue even if unpaid, often significantly increasing the size of the debt.

Wage Garnishment

The federal government and guarantee agencies can garnish your wages administratively. This is in contrast with lenders of private student loans, who must obtain a court order to garnish your wages.

If a guarantee agency or the US Department of Education will be garnishing your wages, they are required to provide you with 30 days notice and to offer you the opportunity for a hearing. You have 15 days from the date the garnishment notice was mailed to file a petition asking for a hearing. The hearing will be conducted by an administrative law judge or other hearing official not under the control of the guarantee agency. (Unfortunately, this does not mean that the hearing official is impartial.)

This hearing represents an opportunity to challenge the wage garnishment. Borrowers should always demand proof of the existence of the debt and the amount of the debt, such as a copy of the original promissory note. Guarantee agencies often have very sloppy records and may not be able to prove the existence of the debt. A computer printout or similar business records do not represent proof that the amount is owing. It's merely an assertion that the debt exists, not proof that the debt is really owing. Borrowers should also ask for and review a complete copy of the repayment history on the loan, as there may be errors where payments were not properly credited to the account or where payments are missing.

The Higher Education Act does not permit wage garnishment of borrowers who have been laid off or fired from their jobs until they have been employed for at least 12 continuous months.

Low-income borrowers should also verify the accuracy of the wage garnishment amount. Most guarantee agencies set the wage garnishment amount at 15% of disposable pay (gross income after subtracting amounts required by law to be withheld) because that's the maximum allowed by law. But the regulations and statute require that the borrower be left with weekly earnings after the garnishment of at least 30 times the Federal minimum wage. Sometimes this yields a lower wage garnishment amount.

Offsets of Income Tax Refunds

If you have defaulted on your federal education loans, the federal government or a state guarantee agency may intercept your federal and state income tax refunds (or other payments from the federal government) and offset them to satisfy the debt. They will send you a notice within 45 days of paying a lender's claim on your defaulted loans, and may not initiate an offset until 60 days after they have sent this notice.

If your income tax refunds have been attached and your filing status was married filing joint, you should ask for a hearing (administrative review) and fight it using the innocent spouse defense (sometimes called the injured spouse defense). While the government has the right to your income tax refunds, they do not have the right to your spouse's share of the income tax refunds. (That is, unless he/she has also defaulted on his/her student loans.)

If you have questions about a Treasury Department offset of your income tax refunds, you can call 1-800-304-3107.

Default Rates

The US Department of Education uses three different definitions when calculating default rates:

  • Cohort Default Rate. The cohort default rate is the percentage of federal education loan borrowers who enter repayment in one federal fiscal year and default before the end of the next fiscal year. This short-term measure of defaults is used to determine a college's eligibility to participate in federal student aid programs. If a college has at least 30 borrowers entering repayment and its cohort default rate is more than 40% in a single year or more than 25% for three years in a row, it loses eligibility. The cohort default rate is also used to determine whether a college is eligible for an exception to certain rules. For example, the requirements for a 30-day delay for first time borrowers and multiple disbursements are waived for colleges with cohort default rates of less than 10%.

    The cohort default rate is a very weak measure of defaults. Given that a default does not occur until a payment on federal education loans is more than 270 days late, lenders have 90 days to file a claim on a default, and Stafford loans do not enter repayment until the end of the 6 month grace period, the cohort default rate is mainly a measure of the percentage of borrowers who never begin making payments on their loans or stop making payments within the first year of graduation.

    The US Department of Education publishes official cohort default rates for schools and lenders and guarantee agencies on an annual basis.

    The cohort default rates tend to correspond to the interest rates on education loans.

  • Budget Lifetime Default Rates. The Budget Lifetime Default Rate is a projection of the percentage of federal education loan dollars entering repayment in a federal fiscal year that will default within the next 20 years. These default rates are reported in the President's budget. The default rates can change significantly from one year to the next (especially the differences between estimated projected rates and "actual" projected rates). It is unclear whether these changes are due to the sensitivity of the model to inflation and other economic factors, changes in the model from one year to the next, or political considerations.

  • Cumulative Lifetime Default Rates. The cumulative lifetime default rate is the percentage of federal education loans that enter repayment in a particular federal fiscal year and default before the end of the current fiscal year. These default rates increase as the number of years of data increase.

All of these default rates are based on the federal fiscal year, which runs from October 1 to September 30. The federal fiscal year is offset relative to the academic year, which runs from July 1 to June 30.

It is worth noting that these definitions of default rates differ on several factors:

  • Basis: Borrowers, Loan Dollars, Loans
  • Time Frame: 2 years, 20 years, from repayment inception
  • Institutional Category: different definitions based on institutional level (< 2 year, 2 year or 4 year) and control (public, private, proprietary, foreign) and borrower year in school (freshman/sophomore, junior/senior, graduate student)
These default rates are published annually in late November. For example, the default rates through September 30, 2007 where published on November 30, 2007.

Two-year and proprietary institutions tend to have the highest default rates, more than twice the default rates at four-year, public, and private non-profit institutions. Graduate and professional students have among the lowest default rates, about half the average.

Private student loans tend to have long-term default rates that are about half of the default rates on federal education loans, partly because they exclude most borrowers with credit scores below 650. The federal government lends to a riskier population of borrowers because the government is focused on enhancing access to higher education, while private lenders are focused on profitability.

Defaulting on Private Student Loans

There are some differences between defaulting on federal student loans and private student loans. While federal education loans define a default as occurring after 270 days of non-payment, for private student loans a loan is considered in default after 120 days of non-payment.

Private student loans also have fewer tools for averting default. For example, the forebearance period on a private student loan is usually no more than a year, in six month increments. Most private student loans do not have discharges for death or total and permanent disability of a borrower. (Sallie Mae's Smart Option Loan, New York HESC's NYHELPs and all Wells Fargo private student loans provide a death and disability discharge.)

Private student loans cannot attach federal and state income tax refunds or prevent the renewal of state licenses, but they can sue under state loan to garnishee wages to repay a defaulted debt. They are also excepted from discharge by bankruptcy unless the borrower files an undue hardship petition that is granted by the court.

More Information

For information about the factors that contribute to default, see Erin Dillon, Hidden Details: A Closer Look at Student Loan Default Rates, Education Sector, October 23, 2007. This report is based on data from a June 2006 NCES report and not on the official cohort default rate data. The report's key findings are:

  • Defaults are more likely to occur four years after the start of repayment. Current cohort default rates are based on the first two years of repayment.
  • Default rates increase with higher debt levels, with a nearly 20% 10-year default rate for students graduating in 1992-93 with more than $15,000 in debt, more than twice the overall average default rate.
  • Default rates declined with increasing income quartile, with the lowest income quartile in 1994 more than four times as likely to default as the highest income quartile.
  • Significant differences in default rates according to race, with African-American students defaulting at four times the overall average default rate and Asian students at less than half the overall average.

See cohort default rates for additional technical detail concerning default determination and cohort default rates.

See loan cancellation and discharge forms for the forms used to apply for a discharge for various reasons such as total and permanent disability, school closure and identity theft.

 

 
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