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What to do when you can't pay student loan

Investigate payment postponement options

A borrower who can't make payments at all has a few options, provided the lender is notified before the loan goes into default, says Kimberly Carter, manager of repayment assistance for American Student Assistance, a nonprofit student loan guarantor agency that provides debt management services and insures private lenders against the risk of default on college loans.

"Everyone in the federal loan program who can prove that they have financial hardship is entitled to a deferment, provided that they meet eligibility requirements," says Carter. "In deferment, payments are postponed for up to a year. And if you have a subsidized loan, the government will pay the interest for that time."

According to the Department of Education, the most common reasons for deferment are inability to find full-time employment, economic hardship and military duty.

Depending on the type the borrower seeks, the deferment may be renewed for up to three years without affecting the borrower's credit score. A student seeking deferment must provide documentation of economic hardship for each year in the deferment period.

Borrowers with private loans and those who don't qualify for federal loan deferments can request a forbearance, says Wilson.

"A forbearance is an agreement between the lender and the student that suspends payments for up to a year," he says. "During the forbearance period, the interest is capitalized, which means it's added back into the loan balance. People who use forbearance will see their balance grow."

The difference between deferment and forbearance is that while federal loan borrowers are entitled to a deferment, a forbearance is at a lender's discretion, Wilson says. For federal loans, students can apply for forbearances each year for up to three years and must provide documentation. For private loans, documentation requirements and forbearance lengths vary from lender to lender.

Like the income-contingent plan, the income-based repayment option requires grads to make regular payments (excluding deferment and forbearance periods) for 25 years, after which any leftover principal is canceled.

A final option is to opt for a temporary interest-only repayment plan. Unlike the aforementioned repayment options, interest-only plans are available only for a specific amount of time to be negotiated between borrower and lender.

Research loan cancellation and forgiveness

Borrowers who have exhausted their deferment, forbearance and repayment plan options can seek loan cancellation and forgiveness options if they qualify.

Borrowers in service positions such as teaching, nursing, the military and public defense could get their loans canceled through federal or state-sponsored programs. Although a few states, such as Kentucky, California and Iowa, have either severely reduced or eliminated their loan forgiveness programs in certain fields, many states will still forgive up to four years of the total cost of college for students who meet eligibility requirements.

Loan forgiveness is also available through national organizations such as the National Health Service Corps and The American Occupational Therapy Association.

While loan forgiveness eligibility requirements for national organizations vary, those in public service positions seeking loan forgiveness through the federal government must first make 120 payments on their loans, starting after Oct. 1, 2007. As long as borrowers stay in their given field, Uncle Sam will forgive any debt after those payments.

Borrowers who aren't in service fields can have up to 70 percent of their loans canceled by serving in the Peace Corps, Americorps or Teach For America. Borrowers who take this route won't have to make any payments before receiving loan forgiveness.

Borrowers who suffer extreme circumstances, such as permanent disability, could get their loans canceled through bankruptcy, but this route requires substantial documentation and works in very few cases.

Dig out of default

"(Federal loan) borrowers that have already defaulted need to call their lender and ask about rehabilitation programs," says Carter. While American Student Assistance and other organizations have shut down their loan rehabilitation programs because of the current economic downturn, a few still allow federal borrowers to get out of default by making nine or 10 consecutive loan payments.

Christen says that organizations that don't currently offer rehabilitation options may be able to work with defaulted borrowers to create a customized payment plan.

"In this environment, lenders want to work with you to make sure you're successful," she says. "Nobody wins if someone defaults."

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