Student loans can spell major trouble © pogonici/Shutterstock.com
Student loans can spell major trouble

Even if you think you’re doing everything right with your student loan, you can still wind up in fiscal hot water. A 2012 study by the Consumer Financial Protection Bureau shows that graduates who consider themselves responsible borrowers still land in student loan trouble when it comes to switching repayment plans, understanding the terms of loan default, correcting mistakes on their accounts, attacking issues with loan co-signers, and the list goes on. To help you navigate the Wild West of student loans, here are some unexpected ways even the savviest of borrowers get burned.

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I made payments on time, but I’m in default

I made payments on time, but I'm in default © HamsterMan/Shutterstock.com

Believe it or not, it’s possible to do absolutely everything right on your student loan and still default, says Jenna Robinson, director of outreach for The John W. Pope Center for Higher Education Policy in Raleigh, N.C.

“If there is a ‘universal default’ clause in the loan, then defaulting on credit cards or medical bills or some other kind of debt can allow the lender to treat that borrower as if he or she has defaulted on the student loan and demand payment (for the full loan amount) immediately,” Robinson says. “A similar kind of clause is not allowed for credit cards and hasn’t been since 2009, but there are fewer protections for student loan borrowers than there are for credit card borrowers.”

Federal student loans don’t have universal default clauses, Robinson adds, and neither do some private loans. Those who are thinking about getting a student loan from anywhere other than the federal government should research whether their other debts could impact their student loans.

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I co-signed a loan for an ex who won’t pay

I co-signed a loan for an ex who won't pay © Sinisa Bobic/Shutterstock.com

Regardless of how your relationship with the borrower changes, if you co-sign for a private loan (federal loans don’t require co-signers), you’re still on the hook until it’s paid off, says Mark Kantrowitz, publisher of the college finance sites FinAid.org and Fastweb.com.

“A co-signer is a co-borrower, equally obligated to repay the debt,” he says. “It shows up on your credit report as your debt. If the primary borrower is late with a payment, it shows up as a delinquent payment on your credit report.”

That means if you’re a co-signer and the borrower defaults on their loan, you’ll need to either pay off the loan yourself or suffer the consequences, which may include late fees, collection costs, a hit to your credit score, wage garnishment or court expenses.

Some lenders do offer co-signer releases, though they’re typically only granted if the borrower can prove they can financially handle payments for the remainder of the loan. Eligibility requirements vary from lender to lender.

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My payment wasn’t applied to the account

My payment wasn't applied to the account © Temych/Shutterstock.com

Lenders, loan guarantors and collection agencies make mistakes, too — sometimes big ones that can result in harsh penalties for the borrower. If you think those holding your loan have made a mistake, try to address it with them first, says Isaac Bowers, senior program manager of educational debt relief and outreach for the nonprofit public interest law group, Equal Justice Works. If the problem can’t be remedied, file a loan dispute with a student loan ombudsman.

“(Ombudsmen) are a neutral and confidential third party who will work with the graduate or the student who has the problem, … gather information from the other party, usually a servicer that they’re having trouble with, then try to work out a compromise between those parties if there is a dispute,” he says, adding that ombudsmen are not advocates for the borrower.

Federal loan borrowers can seek help through the Department of Education at Ombudsman.ed.gov, while those with private loans can get help through the Consumer Financial Protection Bureau.

To help move your case along, Bowers recommends gathering documentation such as promissory notes, canceled checks and bills before filing your dispute.

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My payments are getting more expensive

My payments are getting more expensive © Fesus Robert/Shutterstock.com

That’s a common problem borrowers with variable-rate loans encounter, says Robinson. While all federal student loans and some private loans come with a fixed interest rate, meaning you’ll pay the same interest rate for the life of the loan as long as you stay in the same repayment plan, some private loans have variable interest rates that fluctuate over time.

Several private lenders, including Wells Fargo and Discover, determine interest rates on variable student loans by taking a fixed “margin rate,” which is largely based on your credit profile, and adding it to the “prime rate,” which is the rate at which banks will lend money to their most creditworthy customers.

“The variable rate is going to be pretty inexpensive right now. However, you can’t count on that for the life of a student loan,” says Robinson. “With a variable rate, even though it sounds good upfront, that might not be the case when you finish school and are paying 10 years later.”

The prime rate is currently low at 3.25 percent; however, just 13 years ago, it was nearly triple the rate it is now.

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My debt isn’t substantially decreasing

My debt isn't substantially decreasing © Karen Roach - Fotolia.com

According to the Department of Education, once a loan goes into default, whoever holds the loan — whether it be the federal government or a private lender — can demand the entire loan balance immediately. If you can’t pay it, the loan can go to a collections agency where it becomes harder to pay off.

“When you default on the loan, 20 percent of every payment will be deducted for collection charges,” says Kantrowitz. “It’s only the remaining 80 percent that will be applied to the new interest that accrues, as well as the principal balance of the loan.”

If you can’t pay collections charges on your federal student loan, the government and other loan holders can pull up to 15 percent of your disposable income from your paycheck and withhold money from your federal income tax refund or Social Security checks.

Borrowers with loans in default can get out by paying off the loan in full, taking out a consolidation loan, or, more likely, entering a loan rehabilitation program in which you and the lender “agree on a reasonable and affordable payment plan,” reports the Department of Education.

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After bankruptcy, the loan bills keep coming

After bankruptcy, the loan bills keep coming © olivier/Shutterstock.com

Unlike credit card bills, auto loans and other kinds of debts, student loans can’t usually be dismissed in bankruptcy. According to the Department of Education, borrowers can only discharge their debts through bankruptcy by proving that they have made efforts to pay back their loans, but doing so would permanently prevent them from maintaining a minimal standard of living. The Consumer Financial Protection Bureau also reports cases where private loan borrowers found their loans in default when their co-signer declared bankruptcy.

Before going the bankruptcy route, examine the other options, says Andrew Gillen, research director at Education Sector, a nonprofit education analysis group in Washington, D.C.

“Probably the biggest mistake (borrowers make) is not taking advantage of the existing safety nets,” he says. “For federal loans, there’s forbearance, there’s deferment and there’s … income-based repayment. These are all designed to provide essentially a safety net for students who are getting in trouble with their student loans.”

Private loans may or may not have those protections. Many private loans do include deferment and hardship provisions, but rules and eligibility requirements vary from lender to lender.

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