Recovering from defaulting
on your student loan
Once you default on a federal student
loan by failing to pay for 270 days, things can get awfully bleak
Your wages could be garnished. You could be sued.
Your federal and state tax refunds could be seized. And your already
banged-up credit rating will take a real nose dive.
With a default on your credit record, you'll have
an awfully tough time qualifying for a mortgage or auto loan or
even a credit card.
"Some but not all lending institutions
will look at a student loan default as worse than a bankruptcy,"
says Betsy Mayotte, manager of regulatory compliance at American
Student Assistance. "It's a very serious black mark on your
You'll also have some very serious collection costs
to pay -- as much as 25 percent of the defaulted loan balance. And
through it all the collection calls and letters will keep coming
"The federal government can be expected to collect
on a student loan for at least 25 years," says Dana Callihan,
vice president of external relations for EdFund.
Cleaning up your default mess
It may feel like there's no way back from a defaulted loan, but
there is. It's possible to rehab your credit and get that default
wiped off your credit record for good.
Rehabilitating a defaulted student loan won't be
quick or easy, but it's the best way to get your life and your credit
back on track.
To rehabilitate a loan, you need to make nine to
12 consecutive, on-time monthly payments. The loan is then sold
to a new lender, and the default gets wiped off your credit record.
"A lender buys back a defaulted loan so it's
like it never happened," Sue McMillin, senior vice president
for customer relations and business operations at Texas Guaranteed.
After rehab, you're left with a new loan in good standing,
and your credit record is cleaned of the default. But smaller bruises
on your credit will stay. Black marks for missed payments prior
to the loan's default remain on your credit record for seven years.
By rehabbing your default loan, you also regain all
the rights and payment options of federal student loan borrowers.
For example, your loan payments could be deferred if you're unemployed
or you decide to go back to college.
You also have the options of choosing an extended,
graduated or income-sensitive repayment plan on your new loan. With
an extended payment plan, you make minimum payments of at least
$50, but you can take up to 30 years to repay the loan. With a graduated
repayment plan, your payments start out low and then increase, typically
every two years.
With an income-contingent repayment plan, your monthly
payments are adjusted each year based on your income and loan debt.
Calculators on FinAid
site let you compare monthly loan payments on each type of repayment
The loan consolidation and
Another repair option for folks with a defaulted loan is loan consolidation.
To qualify for a loan consolidation, you'll need to make up to three
months of consecutive on-time payments. Once you make the required
payments, you can obtain a federal consolidation loan just like
any other borrower.
With a federal consolidation loan, your lender pays
off the balances of all the loans you choose to consolidate and
then issues you a new loan. A consolidation loan can lower a borrower's
monthly loan payments by as much as 40 percent and stretch out the
Once you consolidate your loan, your credit report
will be updated to reflect that your defaulted loan is paid in full
via consolidation. The original default notation stays on your credit
report for seven years.
"It's an improvement but it's not a complete
clean up of a borrower's credit," says Bob Murray, a spokesman
for USA Funds, the nation's largest education loan guarantor.
Defaulted borrowers who want to boost their credit
in a hurry -- often so they can qualify for a mortgage -- tend to
"Literally within a three- to six-month
period you can get your credit picked up pretty quickly," McMillin
A defaulted borrower whose top priority is returning
to school has another option to consider. By making six consecutive
on-time payments, you can re-establish your eligibility for federal
financial aid. That way, you'll be able to use federal loans to
help pay for any future education plans.
But you'll still have to make monthly payments on
the defaulted loan while you attend classes. To be eligible for
deferment on a defaulted loan, you must either rehabilitate the
loan or consolidate it.
The pay-off option
The final option for a defaulted borrower is to pay off the loan
amount in full. The defaulted loan will remain on your credit report,
but it will be updated to show that the loan has been paid in full.
Of course, most defaulted borrowers can't afford to
do that. But it's important to do something.
The longer you wait, the bigger your defaulted loan
balance will grow. Paying something, no matter how small, is better
than paying nothing. And the collection letters and calls won't
stop until you pay.
So call your guarantor or its collection agency, explain
your current financial situation and ask about repayment options.
"The biggest mistake I see student loan borrowers
make is not making the phone call," Mayotte says.
"Just make the call. We're not the big, bad collection
agency that's going to threaten their mother. We want to help them."
Making the call is good advice for any student-loan
borrower who is struggling to pay or falling behind on loan payments.
Talk to your lender. You may qualify for forbearance or deferment,
but you'll never know if you don't make the call.
"Whether it's 30 days delinquent or 180 days
delinquent, they need to get on the phone with their lender and
figure out what their options are," Callihan says. "The
best option is to stay out of default."