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What Happens When You Default on Your Student Loans?

What Happens When You Default on Your Student Loans?

As of July 10, 2021, one out of every ten Americans has defaulted on a student loan, and nearly 8% of all student loan debt is in default (according to Education Data). Also, around 15% of all student loans are in default at any one time, on average.

Find out what happens when you default on your student loan, and what you can do to avoid that.

What Happens When You Default?

Chances are, the loan holder will have made several attempts to contact you either through email, snail mail, or telephone calls. Whether you missed these attempts accidentally or were simply unable to pay them, lack of responses results in a default status.

The first day you miss a loan payment, it automatically goes into delinquent status. Until your loan payments are caught up, it will remain that way. After 270 days for a federal loan and 120 days for a private loan, you’re considered in default, and you could face some serious ramifications.

What happens during a default:

  • The lender makes attempts to collect the debt owed.
  • If the lender can’t collect from you, they’ll sell to a debt collector who then tries to collect the debt.
  • The credit companies are contacted, and your credit score is negatively impacted.
  • If you keep ignoring the issue, you’ll find yourself taken to court in an attempt to legally collect the debt.
  • You will lose the court case, and the debt collectors are entitled to garnish 10-25 percent of each paycheck.
  • Lenders will also be given access to your bank accounts, which they will be authorized to withdrawal from.
  • Liens will be attached to any property you own, which will affect any sale and could potentially lead to foreclosure.

Other negative impacts that could occur are:

  • Your default will be reported to all three of the major credit bureaus, which will have a severe influence on your credit score, potentially impacting any future large purchases such as a car or house or even buying and selling any type of real estate. You will have issues trying to get credit cards, too.
  • Defaulting could prevent you from being able to rent an apartment or get a cell phone, homeowners insurance, and utilities such as cable or electricity.
  • A Treasury offset could be called upon, which means any tax refunds would go directly toward paying back the loan.
  • You could, and probably would, be taken to court. All the court fees would be tacked on to your loan.
  • Your credit will have a scarlet letter next to it for years.
  • Your college transcripts may be withheld until your loan payment is made.
  • You lose all beneficial options such as loan forgiveness, deferment, and forbearance.
  • The government can (and will) take a large chunk of your paycheck every month until the loan is settled.

What Does it Mean to Default on a Student Loan?

Defaulting is different from being delinquent. When you default on a loan, it means you went from being behind to completely neglecting payments for an extended period.

If you suddenly realize you haven’t paid on your student loan and are concerned about it heading into default, you can reach out to your loan holder instead of waiting for them to find you. The sooner you take any action, the better. You want to have the chance to make some sort of reasonable accommodation to, at the very least, preserve your credit.

The Difference Between Private and Federal Student Loans

The different types of student loans are federal or private.

Federal loans are those you’d get from the government. What to know about federal student loans:

  • They have better and fixed interest rates.
  • Payments are deferred until you graduate, leave college, or are enrolled less than full time.
  • Your monthly payment is formulated based on your income.
  • Cosigners aren’t necessary, so you aren’t putting anyone else's credit at potential risk.
  • The government pays your interest.
  • You can temporarily defer payment or make arrangements for lower payments.
  • You can pay the loan off early without being penalized.
  • No credit check is needed.
  • Default happens after nine months of non payment.

Private student loans are from other lending sources such as banks, credit unions, and anywhere else not associated with the federal government.

What to know about private student loans:

  • You have to start repayment while you’re still a student.
  • Interest rates can be greater than 18 percent.
  • You have to pay both the interest and the principal.
  • Credit checks are required.
  • You may need a cosigner.
  • You can’t deduct the taxes.
  • Each lender may have different payment options.
  • There may be a prepayment penalty (the lenders make money off the interest, so the longer you take to pay off the loan, the more money they make).
  • Most private lenders do not offer loan forgiveness programs.
  • Default happens after 120 days of non payment.

Can I Get Out of Default Status?

Once your loans go into default, it creates a situation that can be complicated to get out of. Your federal loans no longer are eligible for loan forgiveness, and your private loans start going into collection status.

There are, however, a few different ways available for getting out of default for your federal student loans:

  • Loan consolidation: A Direct Consolidation Loan can be used if you have one or more federal loans that are in default. There will be a repayment expected, and you will need to be able to pay those to stay in your consolidation. You are only able to consolidate your loans once, so you need to make sure you pick the right one. Expect collection costs to be applied to the principal balance of your consolidation. To qualify for this, you will need to make three payments of an income-based repayment plan. To make arrangements for loan consolidation, you need to apply through the Department of Education.
  • Loan rehabilitation: You have one shot, and one shot only, to do a loan rehab for your federal and private student loans. This is an arrangement that must be made with the Department of Education, where you will determine a repayment plan that is affordable to you and reasonable to them. Nine out of 10 of these payments MUST be made on time, or you will go back into default. The payment will be based on your income, or 15 percent of your discretionary income calculated by submitting pay stubs, W2s, or 1040s.
  • Loan cancellation: There are extenuating circumstances that lead to the complete cancellation of your student loans. They get wiped clean if you:
    • Attended a school that closed while you were enrolled
    • You left the school 120 days prior to its closure, rendering you unable to complete your education
    • The school falsified your federal student aid eligibility

If any of the above events occurred, you need to contact the U.S. Department of Education Federal Student Aid processing group.

  • Loan payoff: If you’re in default, and you have resources to come up with the sum total of what you still owe to your student loan, then you can make arrangements to pay it off in one lump sum.

Getting out of default from your private loan

You’ll need to act in a timely manner if you want to get out from under the crushing effects of default:

  • Ask your lender for options. They are sometimes able to lower your payments temporarily, or halt them altogether for a specific amount of time.
  • Look into refinancing at a lower interest rate.
  • Negotiate a lump sum pay out, which may be less than the original cost of the loan.
  • Find a student loan lawyer to learn about your rights as a borrower.

8 Tips for Paying Off Your Student Loans Quicker

Paying back student loans is tough. It takes away from any disposable income you may have, and can induce a financial strain. Following is a list of tops for paying off your loans quicker, so your pockets can be deeper in the future.

  • Prioritize high interest rate loans: Pay the minimum amount toward loans with lower interest rates, and pay greater amounts toward those with higher interest rates.
  • Pay extra on principal: You’ll need to check with your lenders, but some will allow you to tack on extra money directed toward the principal part of the loan. If you can afford it, consider making your loan payments larger so you can get them paid off earlier. Even an extra $25 per month will cut down the length of your repayment. If you’re making payments while you’re in school, make sure those are going directly to the loan principal, especially if it’s a loan with deferred interest.

  • Pretend it’s part of your mortgage: You don’t want to be at risk for losing your home, whether you own or rent. So, when figuring out your monthly housing payment, incorporate your loan payments into it and pay them as you would your mortgage.
  • Create a repayment fund: Set aside a bit of your paycheck each month into a savings account that is separate from any other accounts you might have. That account can act as your designated loan repayment fund.
  • Refinance your loans: If you’re knee deep in private student loans, you can consolidate and refinance at a lower interest rate if your lender allows.
  • Find a loan forgiveness-approved job: Certain careers come with the benefit of loan forgiveness, which means you don’t have to pay it back. If you go into public service or education, you may be able to have at least part of your federal student loan forgiven. There are some rules of eligibility that apply.
  • Live a little under your means: If you’re really serious about paying your student loans off faster, than consider living frugally. Rent a less expensive apartment, drive a used car with low payments, or take public transportation. Find ways to save and put those extra dollars toward your loans. The quicker you pay them off, the freer you are to live life on your terms.
  • Have a side hustle: Consider picking up another side gig in order to make more money. It can be anything, from doing freelance work after your regular work hours, to using your hobby and selling things online or at craft shows. That extra income can be used to counteract all the loan payments you have, or you can apply it toward the loans as well.
  • Get a lower interest rate: When you have loans, signing up for autopay will drop your interest rate by .25%. That may not seem like much, but that’s a few hundred dollars to a few thousand saved over the course of the loan. By enrolling in autopay, you’re guaranteed to pay on time, which decreases your chance of defaulting on the loans. Not to mention, after a determined amount of on-time payments, many lenders lower the interest by another .25%.

It’s obvious that the best thing to do is make your student loan repayments in a timely manner, if it’s at all possible. But if you find yourself struggling, then make arrangements for your loans so you can avoid going into default entirely. There is a light at the end of the loan repayment tunnel. Be patient and diligent, and you’ll get there.

Learn more about financial aid in our financial aid guide.