Defaulting the loan obligations can be overwhelming. However, one should not feel alone if the loan defaults as thousands of student loan borrowers share the same worries. In this challenging situation, the worst thing is ignoring the default because it brings multiple adverse effects, such as a damaged credit score. Luckily, getting out of default is possible in several ways. Student loan rehabilitation and consolidation are more prominent among these options. However, they have many differences, which make the selection process difficult. Therefore, in this guide, we will explore both solutions and help borrowers to decide on the most suitable alternative to get out of default successfully.
What is Loan Default?
Before we start discussing student loan rehabilitation and consolidation, it is better to understand the problem- default- first. Student loan default happens when borrowers do not satisfy the loan contract requirements by not paying the obligations. Depending on the loan type, the non-payment period for default can change. If a borrower has federal debt, it enters default when nine months or 270 days past the due date. In this case, Perkins loans are exceptions because they default as soon as the borrower misses a scheduled payment.
In the case of private loans, usually, default happens if three payments are missed. However, the conditions can change depending on the lender. Hence, it is better to check the promissory note of the loan for determining default terms.
If a borrower is not sure if the debt is in default, there exist several ways to check it. First, debtors can contact loan servicers, which is the fastest method of getting reliable information. Checking this info online is also possible with the help of FSA ID. When entered into the system, borrowers can see if the loan is listed as default. Lastly, debtors can get their credit reports and pay attention to the negative information section. Keep in mind that retrieving a credit report is free and can happen once a year.
Why Avoid Default?
Student loan default brings many adverse effects that urge borrowers to utilize student loan rehabilitation or consolidation to get the loan out of default.
First, defaulting does not mean that the borrower would eliminate the debt. The loan holder can still collect the payment through other ways, such as through wage garnishments and tax refunds. In the case of private lenders, they cannot take the tax refunds from the borrowers, but they can sue the debtors. If they win the case, they will access the debtors’ bank accounts or paychecks to collect their money.
The late payments and the following default will have a negative effect on credit performance for an extended period – up to seven years. During this time, the downgraded credit will cause troubles in typical life activities such as renting an apartment, getting insurance, or even a job. Besides, if debtors attempt to get a new car or home through borrowing, they will face higher interest rates.
Increased Payment Obligations
Even if the debt is in default, the interest payments and penalties for late payments will continue to accumulate. Besides, there will be additional charges to collect defaulted payments. These collection costs can be as high as 25% of the loan balance.
Issues in Academic and Professional Life
Debtors who default their obligations might not get additional loans or any federal help to pay the school fees. If they have already graduated, the school can decide to withhold the academic transcript until they pay the debt. In professional life, the consequences can be as severe as losing the license. Sure, license suspension laws and regulations depend on the states, but it is a common practice for debtors in medicine or teaching fields. This effect can even apply to driver’s licenses.
Getting Student Loans out of Default
As mentioned before, several ways exist to get out of default. The first method is repayment, which involves repaying the whole debt. However, there is a low probability that a defaulted borrower will afford such a lump-sum payment method. Additionally, declaring loan bankruptcy is also possible, but it will have a long term adverse impact on credit score. Besides, it is hard to prove the bankruptcy case. Hence, we will skip these two options and focus on more frequently used strategies- Student loan rehabilitation and loan consolidation.
What is Rehabilitation?
One of the most beneficial solutions for default is student loan rehabilitation. Rehabilitation involves making nine monthly payments during a ten-month period. The payment amount can change, but it is usually equal to 15% of discretionary income. Keep in mind that discretionary income is the portion of revenue left after paying necessities, like shelter and food. Hence, a borrower with consistent income can enjoy this solution as payments will be lower. It is also possible to request a lower payment amount. Borrowers can utilize this method only once for their loans. Hence, if debtors apply this solution, they need to ensure that they can afford the payments during the required period.
Federal student loan rehabilitation does not apply to private loans. Hence, debtors with private loans can contact their lenders and ask for a solution to get out of default. Sometimes, negotiation and settlement work for private borrowers.
What Happens after Student Loan Rehabilitation?
If debtors can successfully rehabilitate the debt, the default status will be raised from their loans. The collection of payments and wage garnishment will cease, and the debtor will again qualify for benefits such as student loan forgiveness, repayment plans, forbearance, etc. Student loan rehabilitation will also remove the adverse impact of default on credit performance, but the late payments before the default will remain.
What is Consolidation?
Student loan consolidation involves two options. First, debtors can agree to an income-driven repayment plan for a new direct loan. Alternatively, consolidation happens when a borrower makes three consecutive payments voluntarily for the defaulted loan. Voluntarily means that the borrower pays with his/her own will, not through wage garnishment or collection. In this case, the amount is determined by the loan holder, but it should still be reasonable. Loan consolidation can be applicable to multiple loans or single federal debt.
The Differences between Student Loan Rehabilitation Consolidation
Both options have advantages and disadvantages, which make it difficult to choose. Starting with rehabilitation, it has a huge benefit that consolidation does not provide- improving credit performance. Rehabilitation removes any negative effects of default from the credit report. However, late payments will still be visible. Second, federal student loan rehabilitation does not involve collection costs, which we discussed previously. Consolidation, on the other hand, requires collection costs, which can be as high as 18.5% of the loan balance. Hence, it increases the amount owed. On the bright side, consolidation is much faster than rehabilitation. If a student needs an urgent loan to go back to school or get out of the default for a new federal aid, consolidation is a better option.
It seems like consolidation is not better than rehabilitation because of its non-impact credit performance and high collection costs. However, compared to the substantial negative aspects of default, it is still beneficial to utilize consolidation and rehabilitation to get out of the default.