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Student Loans Student Loan Repayment

Student Loan Rehabilitation vs. Consolidation: Getting Out of Default

Updated Apr 05, 2023   |   6 mins read

Note about changes due to COVID-19:

There have been changes to the federal student loan program as a part of the $2 trillion economic stimulus bill that passed in Congress on March 27, 2020, to help those affected by the Coronavirus.

Until June 30, 2023, 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 before March 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 in the student loan rehabilitation program, skipped payments will still count towards the requirements during this time.

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. You can learn more on our federal student loans page.

If you have recently earned a college degree—or you’re in college now—then you’re probably familiar with student loans. Most college students end up graduating with student loan debt, and that debt can end up being quite the financial burden for some graduates who are just getting started in their new careers.

Those who find themselves unable to make their federal loan payments are considered delinquent after the first missed payment. After a few months, depending on the loan, delinquent borrowers are considered to be in default—which is a financially disastrous situation to be in.

What Happens If You Go Into Default?

If your loans go into default, the entire balance is immediately due and payable; you no longer have repayment options over time. In addition, you’re ineligible for any other federal aid until that balance is paid, and your default is also reported to the three major credit bureaus.

>> Read More: Options If You Can’t Pay Your Student Loans

Your credit score will drop significantly, and you could find yourself unable to be hired for many different jobs, or have difficulty buying a house or even just renting an apartment.

Default is not a minor issue—and it can affect a lot of things in your life besides just your credit rating, including your federal income tax refund, which may be kept by the government to pay your debt.

If you’re already in default, however, there are options that can help you get out. Two of the most popular ones are student loan rehabilitation and student loan consolidation.

What is Student Loan Rehabilitation?

Student loan rehabilitation is one way to get your student loan back on track if you cannot make your payments and are already in default. In a student loan rehabilitation program, you agree in writing to make nine separate payments within 20 days of the due date during 10 consecutive months.

The payments must be a reasonable amount; the loan holder will set the payment amount at 15 percent of your annual discretionary income. Discretionary income is considered any part of the adjusted gross income from your tax return that is over 150 percent of the poverty level.

If you can’t make the payment they designate, you may be able to set up an alternative monthly payment based on your income that’s left over after reasonable monthly expenses. You’ll need to provide a list of income and expenses that must be made, such as a mortgage payment, rent, food, and heat. It does not take into account things like Netflix, cable TV, or a gym membership—you may end up needing to cancel those things in order to make your payment.

After you’ve made the nine required payments within that 10-month period, your loans will no longer be in a default status, and will no longer show as being defaulted on your credit reports.

What is Student Loan Consolidation?

Student loan consolidation is another option if your federal student loans are in default. With this, you get a new loan that will pay off all of your other student loans, bringing them all under one payment. While a defaulted student loan is hardly a recipe for getting approved on a new loan with a bank or other lender, the federal government does offer consolidation with a few caveats.

If you’re in default, you can consolidate by making three full monthly payments, consecutively and on-time, as a show of ability and good faith. You can also make a written agreement to pay the loan on an income-driven repayment plan—and stick to it. If your point is to get your loans paid off as quickly as possible, this may not be your best option. If you’re already in default, however, it may be your only option.

There is an alternative to student loan consolidation, but it’s hard to qualify for, which could end the conversation if you’re struggling with default. Student loan refinancing is an alternative to consolidation loans, and it’s offered and underwritten by private banks and lenders. Refinance loans are mainly available to an applicant with excellent credit and high income, but as a result, you could get a new consolidation loan with a lower interest rate.

Student Loan Rehabilitation vs. Consolidation: Which Should I Choose?

Deciding which path to take is largely dependent on your personal situation. There are pros and cons to each, and while you might be worried about knowing which is best, the truth is that if you’re in default, choosing either one is better than opting for neither.

Student loan rehabilitation is good if you need to be able to get more student loans later or need access to other federal programs. Once you’ve made your nine rehabilitation payments, any wage garnishment and Treasury offset stops, and your credit report will show that your loan is in good standing. Any garnishment, however, might continue until those nine payments are made—and that can be financially difficult for many.

Student loan consolidation is a great option if you have more than one loan; after all, consolidating requires multiple loans. It does, however, have some rules and hoops to jump through depending on the type of federal loan you have. You’ll want to check the rules for your specific federal loan.

Coming out of default is difficult—but not impossible. Research the options, choose the best one for your situation, and hang in there. You can be out of default before you know it.