Student Loans: What To Expect When You’re Defaulting
Defaulting on a debt is never pleasant – not for the borrower and certainly not for the lender. And defaulting on a federally guaranteed student loan is especially ugly. Because federal loans are generally not dischargeable in bankruptcy, and the U.S. taxpayer is left holding the bag when you default on a federal loan, you also have the entire resources of the U.S. Government, including the Internal Revenue Service, acting as a collection agent. That means short of total and permanent disability or some other means of qualifying for an undue hardship exemption, that student loan debt is going to hang around like a backache until you get it paid off.
Your precise experience and your options will vary depending on whether you are having trouble repaying a federal student loan or a private loan. It’s not going to be fun in either case, but you should understand what you’re dealing with and what’s in store for you if you default.
In the short run, here’s what you can expect:
You can expect a lot of phone calls. Creditors will call you at home and at work, asking you when they can expect a payment. You do have the right to request that they only call you personally, rather than calling you at work. This is often a good idea if the work calls threaten your job or livelihood or disrupt your working environment. Most creditors will understand completely if you are available to them and responsive to them via your personal phone.
You also have the right to tell them to cease all calls to you, whether at work or at home. However, if you do this, you can probably expect their collection efforts to escalate to the next step. If your loans are private, the lender may sue you. Their aim is to get a judgment against you, which they can then use to get a garnishment order against you, which will force your employer to deduct money from your paycheck and forward it to them.
Most creditors don’t want to do this. They would usually much rather work out a reasonable payment plan. Lawsuits and garnishments are an expensive and inefficient process from their perspective. But if you are unresponsive, you don’t call them back, or if you demand they stop trying to contact you altogether, they will do what they need to do to protect their own interests.
The best thing to do:
Don’t ignore or block their calls. Return their calls promptly, or ask to call them back at a convenient time, and follow through.
Be proactive. Call the lender before they call you.
Explain your financial situation. Nearly all federal loan programs have a number of options – including forbearance, interest only periods and other ideas – to help those facing default avoid actually defaulting. Private lenders vary, of course, but most of them will work with you to at least some extent if you are having difficulties paying.
Don’t leave the lender wondering what’s happening. Stay in touch. Collectors can more easily forestall lawsuits if they know what’s happening in your financial life, and they know you’re not ignoring them.
Although some time may elapse between the time you cease making payments on a federal loan and the time you are formally considered in default, the delinquency will show on your credit report as soon as you’re late. Credit bureaus track 30-day and 60-day delinquencies. Too many delinquencies and you make have your ability to access further credit significantly curtailed. This can make it much more difficult to manage day-to-day financial issues and cash-flow crunches, and severely limit your options.
Your loan may get turned over to a collection agency.
Unless provided in the initial contact, every debt collector must send a written “validation notice” within five days indicating how much money you owe, the name of the creditor you owe, what dispute rights you have if you think you do not owe this debt, and how to obtain information about the original creditor. Keep this notice and use it as a reference when speaking with a debt collector.
Federal loan servicing companies will generally consider you to be in default if you fail to make payments on a federally guaranteed student loan for between 270 and 360 days – unless you sooner make special arrangements with the servicer. Don’t wait that long.
Unlike private lenders, federal student loan collectors can and often do garnish your wages without having to get a court order first. You can expect a 30 day notice before this occurs, though. You will get the opportunity for a hearing prior to the garnishment order going through.
The Internal Revenue Service can also dock any income tax refunds that may be due to you and send them to the Department of Education to apply against your student loan debt.
This isn’t the worst thing in the world – at least you get your debt reduced this way. But I’m sure you’d much rather have the cash, if you expect to get a tax refund.
The federal government may even withhold a portion of your Social Security benefits, if you still owe a balance on a federally-guaranteed student loan.
You may be ineligible for certain government jobs.
You will be blocked from enlisting in the U.S. Armed Forces.
Your default will appear on your credit bureau report for up to 7 years after you actually pay the loan off. This hurts your credit and makes it tough to get a car loan, mortgage or credit cards. If you do qualify for credit, you will likely be required to pay a higher interest rate.
You will be ineligible to receive any more federally-guaranteed financial aid until you pay off the balance, or make an acceptable payment arrangement and make not fewer than six consecutive monthly payments on time.
You will be ineligible for some federal benefits until you are no longer in default.
You will be ineligible for deferments and subsidized interest benefits.
If you hold a professional license, you may not be permitted to renew it.
You will likely be held liable for collection costs, court costs and attorney’s fees required to collect your loan. Collection agency fees are generally added to balances due on federal loans, up to certain limits. So not only are you facing repayment of the original balance – you’ll also wind up paying the fees of the people chasing you down. These can rise to as much as 40 percent of the balance of the loan.
For loans held by the US Department of Education (e.g., Federal Direct Stafford Loans), the department assesses collection costs at a rate of 25% of the outstanding principal and interest due on the loan (or 20% of the payment).
Don’t let the situation fester, even if you are already in default. If you work out a payment plan within 60 days or less of defaulting, some collection agencies will cut you a break on collection fees.
The federal government is usually not willing to settle an outstanding student loan debt at anything more than a trivial discount. They know they have you by the short hairs, thanks to the many different ways they can make your life difficult or ensure recovery of the debt. While you may be able to make a reasonable cash offer in settlement of 20-40 percent off to a private lender who just wants to raise some cash and close the books, you’re unlikely to get any such concession from a federal loan servicer.
Private loans usually have a quicker timeline before they report you to credit agencies as having defaulted – often as short as 120 days of nonpayment.
Every lender will have different policies when it comes to working with borrowers in trouble. In most cases, they are less flexible than federal lenders when it comes to forbearance options. Typical timelines allow for no longer than a year of forbearance, approved in increments of six months.
You may have trouble discharging a private student loan in a Chapter 7 bankruptcy unless you can show a court that paying the loan back would cause an undue hardship.
Private lenders cannot dock your Social Security benefits or your federal income tax refund, however.
Defenses to Garnishment
You are entitled to notice of garnishment proceedings, even if it’s a federal loan and they’re doing an administrative garnishment and are not going through the courts. Generally, if you request a hearing within 30 days of the receipt of your garnishment notice (15 days for FFEL loans), the garnishment process will stop until the hearing is complete.
If you are faced with the possibility of garnishment, always ask the government/servicer for a complete accounting of the debt, including repayment records. Servicers have been known to make mistakes, and miss or miscredit payments. In some cases, they have trouble proving the existence of the debt in the first place. But if you do legitimately owe the money, don’t count on this strategy getting you off the hook!
Under the Higher Education Act, creditors may not garnish wages of debtors who have been laid off or fired from their jobs until they’ve been employed for 12 continuous months or longer.
Other possible defenses include the following:
- They have the wrong person. You don’t owe the debt.
- You have already repaid the loan.
- The borrower is deceased.
- You are totally disabled.
- You have already entered into a payment agreement (and you can prove it).
- The loan has already been discharged in bankruptcy.
- You are entitled to a false certification discharge.
- The loan was fraudulent or otherwise not enforceable.
- You are are eligible for a closed school discharge, such as those being granted to many former students of Corinthian Colleges.