Student Loan Default Guide

Note about changes due to COVID-19:

There have been changes to the federal student loan program as a part of the Coronavirus Aid, Relief, and Economic Security Act (CARES Act) that passed in Congress on 3/27/2020 to help those affected by the Coronavirus.

Until September 30, 2021, borrowers have the option to suspend payments without penalty, if needed. Payments made on federal student loans during this time will first apply to unpaid interest accrued from before 3/13/2020, then directly towards the principal balance. In addition, no interest will accrue during this time—effectively setting the rate at 0%.

If you are pursuing Public Service Loan Forgiveness or forgiveness through an income-driven repayment plan, skipped payments will still count towards the monthly payments required to be eligible. The same is true for borrowers working to meeting student loan rehabilitation requirements.

Lastly, the government will not garnish tax refunds or money from other federal benefits of borrowers who are behind on student loan payments during this time.

Paying down your student loan balance can be challenging, and many U.S. borrowers default on their student loan payments every year.

Unfortunately, as student debt continues to grow — with total student loan debt in the U.S. topping $1.5 trillion — it’s estimated that nearly 40 percent of borrowers are expected to default on their loans by 2023, according to a report from the Urban Institute cited by CNBC.

A student loan default is a failure to pay your loans in accordance with the agreement you made with your student loan servicer, but lenders vary on when borrowers cross the threshold from delinquent to default.

In this guide:

• What is Student Loan Default?
• What Happens When You Default on Your Student Loans
• How to Avoid Student Loan Default
• What to Do If You Have Defaulted on Your Student Loans

What is Student Loan Default?

When you enter into a student loan agreement, you make a promise to repay the loans in accordance with the repayment plan offered to you.

As long as you make these payments, your loan is in good standing. But if you fail to maintain this monthly obligation, lenders will label your loans as in default, which can bring about a number of negative consequences, from a damaged credit report to wage garnishment and debt collection fees.

Unfortunately, there is no universal time period that dictates when a loan defaults, and different borrowers abide by different standards. For example, the federal government considers loans to be in default after 270 days, or about nine months, of non-payments.

However, private student loan default is different, as the rules and requirements are determined by the lender and may vary from borrower to borrower.

Though many private student loan lenders have default policies that trigger in about three or four months, they can be as little as one month. Either way, they are typically less than those imposed on federal aid.

To determine the default policy on your private loans, check your promissory note.

What Happens When You Default on Your Student Loans

Once your student loan defaults, a chain reaction of events will likely occur, including calls from your lender or the debt collection agency that was charged with collecting your unpaid debt. However, there are many more consequences to consider.

One of the primary concerns, at least from a consumer standpoint, is the impact a loan default will have on your credit history. Even a single default on a loan can result in a significant decline in your credit score, and default activity will remain on your credit report for seven years. Having a lower credit score will make it significantly harder to secure credit cards and loans in the future, such as a car loan or a mortgage.

Federal Student Loan Default

If you default on your federal loans, one of the first things you will lose is protections and benefits like deferments, forbearance, access to flexible repayment plans, and loan forgiveness.

Additionally, if you remain in default, federal benefits like Social Security and tax refunds can be withheld as repayment. Similarly, the federal government can garnish up to 15 percent of your wages, meaning a portion of your paycheck will be sent directly to the lender.

Finally, when you default, you may also find that you are on the hook for the entire sum of your loan plus interest immediately, and you may also face additional debt collection fees. 

Private Student Loan Default

Defaulting on a private loan also can leave both you and your cosigner vulnerable to a host of negative consequences.

If you default and have a cosigner, the lender will likely start seeking payment from the cosigner. Additionally, the cosigner will also suffer from the same negative credit effects associated with a loan default.

While the federal government reserves the right to garnish your checks or keep your tax return, private lenders must go through legal channels to do so, which means that you and potentially your cosigner will likely be sued by the lender. That can result in legal fees as well as wage garnishment for up to 25% of your paycheck. The lender can also secure a court order to seize assets or place liens on any property you own.

How to Avoid Student Loan Default

If you’re consistently submitting late payments, or if you’ve already missed a monthly payment completely, it could mean that loan default is possible.

If you think you may default on your loans, there are several steps you can take to prevent it including some student loan financial hardship options that you should consider before defaulting.

Contact Your Lender

If you can’t afford to make a payment in the first place, then your next step should be to contact your lender to learn about your options. In some cases, you may be able to enter into deferment or forbearance, though only private loan holders may have access to forbearance.

Revisit Your Payment Plan

If you have a federal student loan, you may be able to enter into an income-driven repayment plan, which might result in a more affordable monthly payment that accommodates your income and family size.

While private student loans don’t offer the same level of protection available to federal student loan borrowers, some private loan programs will offer their own version of flexible repayment options.

Consolidate and Refinance

Both consolidation and refinancing typically allow borrowers to replace one loan, or several loans, with a single loan with one monthly payment. The benefit is typically simplifying federal loan repayment and getting lower monthly payments due to an extended repayment period.

Private loan consolidation, which is frequently referred to as student loan refinancing, is also an option for borrowers who have private and federal student loans.

In the case of private refinancing, you may be able to secure a lower student loan interest rate if you act before your credit has been impacted. Otherwise, you may need a cosigner.

Note that it is unlikely that you will be able to refinance already defaulted student loans or loans that you have missed multiple payments on.

Before you refinance your student loans, it’s important to recognize the potential ramifications, particularly when it comes to moving federal loans to the private space. In this case, refinancing loans, as opposed to consolidating them through a direct consolidation loan, can result in the loss of rehabilitation programs like income-driven repayment plans and loan forgiveness.

What to Do If You Have Defaulted on Your Student Loans

Getting out of student loan default is possible, though your options depend on what type of loan you have.

Loan Rehabilitation

Loan Rehabilitation is available to federal student aid borrowers who have a Direct Loan, a Perkins Loan, or a Federal Family Education Loan. To take advantage of one of these programs, you must voluntarily (e.g., not via wage garnishment) make nine consecutive, reasonable payments (determined by your lender) within 20 days of your due date.

Typically, a reasonable payment is equal to 15% of your discretionary income. That amount is then divided into 12 months payment.

>> Read More: Student loan rehabilitation vs. consolidation

Direct Consolidation Loan

Federal borrowers can also take advantage of a Direct Consolidation Loan, which will consolidate their loans and enter them into a new student loan repayment agreement. In this case, the borrower must agree to participate in an income-driven repayment plan and voluntarily make three consecutive, on-time monthly payments on the defaulted loan, prior to consolidation.

Refinance

In addition to preventing a default, refinancing can also help you get out of default status. If you refinance your loan, you will be taking out another loan to repay the loan that is in default status. Unfortunately, with a default on your credit report, you may have trouble qualifying for a loan on your own. In this case, you will need to consider asking a friend or family member to act as a cosigner on your loan.

Settle Your Debt

In some cases, borrowers who have defaulted on private loans may be able to work with their loan collectors to negotiate a settlement payment. If this is the case, the collector may agree to reduce the total amount you owe in exchange for payment in full.

Though settling isn’t always ideal, it may be worth considering, especially if you’ve exhausted all other options and can pay in full.

The Bottom Line

When you take out a loan, you sign a legal agreement with your lender that includes specific payment obligations. If you consistently fail to meet those obligations, there is a good chance that you will default on that loan and find debt collectors at your door. That can have significant negative implications for your financial health.

There are numerous ways that you can prevent default, many of which start with a call to your lender to discuss your options. However, if you’re already under a default, you do still have options that can help you move back into good standing with your lender and begin to rebuild your credit and your financial life.