After 270 days of delinquency on student loan payments, the loan is in default. If the loan goes into default it is vital to take steps to get out of default. You may get out of default by either consolidating or rehabilitating your student loans. There are various factors to consider when deciding which route is best, so a case by case evaluation is necessary. And, keep in mind, these options are not typically available for private loans unless the private lender agrees.
One option for getting out of default is through loan consolidation. A student loan consolidation allows you to pay off the outstanding balances of the defaulted student loans with a new loan. In order to qualify for a direct consolidation loan, the borrower must have at least one Direct Loan or Federal Family Education Loan (FFEL) that is in grace or repayment status.
A federal student loan that is in default may be included in a consolidation loan after payment arrangements have been made and the borrower has made several voluntary payments. Usually, the borrower is required to make at least three consecutive, voluntary and on-time payments prior to consolidation. Borrowers do not need to make the three payment if they agree to pay the consolidated loan under either the Income Contingent Repayment or Income-Based Repayment Plans.
There are a few downsides and limitations to consolidation. Consolidation can only be done once, depending upon whether the borrower consolidates all student loans. A collection fee of 18.5% of the outstanding loan balance (principal and interest) can be added on to the new loan. Consolidation cannot be done if there is an administrative wage garnishment or judgment in place. The process can take 30 to 90 days to complete. The borrower’s credit report will still show the defaulted student loans with a default notation.
The second way borrowers can get federal student loans out of default is by a loan rehabilitation. In the loan rehabilitation process, the borrower is required to make nine timely voluntary loan payments over a period of ten months. For Perkins loans there must be nine payments over nine months (no skipping). The payments must be “reasonable and affordable”. Generally, a reasonable and affordable payment is the income-based repayment amount, unless the borrower can demonstrate the need for a lower payment based upon necessary expenses.
Once the borrower makes the required nine payments the borrower will receive notice from the new servicer. If it’s a FFEL loan the loan must be sold, so it is advisable to continue to make payments until the borrower receives notice from the new servicer. After notice is received, whether it’s a direct loan or FFEL loan, the borrower should immediately seek an income-based payment plan, if needed.
Just like consolidation, rehabilitation also comes with some downsides. A collection fee of 16% can be added to the loan balance. If a borrower successfully rehabilitates, it can only be cured once this way. If there is an administrative wage garnishment in place, the garnishment only stops after the borrower makes five payments (so the borrower will be making, effectively, two payments – the garnishment and the rehab payments).
On the positive side, rehabilitation can be better for the borrower’s credit. If the borrower successfully rehabilitates, the “default” notation is removed from the credit report. Notations of past late payments, however, will not be removed.