Rehabilitate or Consolidate Defaulted Federal Loans

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If your federal student loans are in default, the stress of dealing with collections agents, wage garnishment, and tax offsets can be enough to make you want to bury your head in the sand.

But doing so will probably only make a bad situation worse.

Instead of ignoring student loan default, you can take action in one of two ways: student loan rehabilitation or consolidation. Each option has its pros and cons, but either will get your federal student loans out of default.

As for private student loans, you will have to speak with your loan servicer about your options. Private lenders rarely offer rehabilitation or consolidation, but they might allow for temporary forbearance during a period of financial hardship.

If your federal student loans have fallen into default, though, here’s what you need to know about getting your finances back on track.

What is default?

Your federal student loans go into default when you fail to make payments, but they don’t do so right away. After your first missed payments, your student loans are considered delinquent.

As long as you make a payment soon or contact your loan servicer to discuss your options, a delinquency will not necessarily hurt your standing or finances.

But if your loan is delinquent for 90 days, it will be reported to the credit bureaus and could hurt your credit score.

After 270 days of missed payments, your student loans go into default. At this point, you will need to take specific actions to get out of default beyond simply resuming payments.

While federal student loans don’t go into default for 270 days, private student loans work differently. Some lenders consider a loan to be in default immediately after you miss your first payment.

Others give you 120 days of leeway to start paying again before your loans are back on track. If you’re struggling to repay a private student loan, speak with your loan provider about your options.

What are the consequences of student loan default?

The consequences of student loan default differ for federal and private student loans. The government has wide-reaching powers when it comes to collecting on debt, so defaulting on federal student loans could have major consequences.

For one, you will lose eligibility for forbearance or deferment. Second, you could get your wages garnished or even face an offset on your taxes. Some older borrowers in student loan default have also been threatened with garnishment of their Social Security.

Whether you have federal or private student loans, going into default could also mean your loans go to a collections agency. As a result, debt collectors might start calling frequently asking for payment. Some even call friends, family, or a workplace to get ahold of a borrower.

Finally, defaulted student loans will likely get reported to the major credit bureaus, meaning your credit score could take a serious hit. A damaged credit score takes time to build back up, and it could make it difficult to take out a mortgage or make other financial moves in the future.

Note that private lenders cannot garnish your wages, taxes, or Social Security, though they could potentially bring you to court to demand repayment. Private loans also have a statute of limitations, whereas federal student loans never go away until you pay them or get loan forgiveness.

3 options for getting out of default

The consequences of student loan default can be serious, so what you can you do to get out of default? Here are your three options.

  1. Student loan rehabilitation

Rehabilitation allows you to remove federal student loans from their default status. If you have more than one student loan, you must apply to rehabilitate each one separately, and you may only rehabilitate a loan one time.

In order to rehabilitate, you must make nine payments within a ten-month period to have your default status removed. Your payments under rehabilitation are expected to be reasonable based upon your financial situation.

The loan servicer will request payments equal to 15 percent of your discretionary income. If you cannot afford those payments, you may ask your lender to recalculate the payment amount based on your documented income and expenses. It’s possible for borrowers in extreme financial distress to have rehabilitation payments as low as $5.

Once you’ve made your nine payments, your loan is considered rehabilitated and the default is removed from your credit history — although the late payments will remain on your credit history. During the period of rehabilitation, you may still be contacted by collection agents since they may continue to pursue borrowers during the process of rehabilitation.

Rehabilitating your loan could result in fees of up to 16 percent of unpaid principal balance and accrued interest to the principal balance of the loan. However, rehabilitation will restore your eligibility for benefits like deferment, forbearance, loan forgiveness, and a choice of repayment plans.

That means you can make the necessary changes to your monthly payments to keep them affordable post-rehabilitation.

  1. Student loan consolidation

The other option for a borrower with federal student loans in default is consolidation. With Direct Loan consolidation, your defaulted loans will be paid off, leaving you with a single, larger loan with one monthly payment, a fixed interest rate, and in most cases, a long repayment term.

Even if the government is already garnishing your wages, you can still roll your loans into a new Direct Consolidation loan. Once you take out the loan, your old loans will be paid off and your wages will no longer be garnished.

There are two ways to qualify for consolidation on a defaulted student loan:

  • Agree to repay your new loan under an income-driven repayment plan.
  • Make three consecutive monthly payments on your defaulted loan before you apply for consolidation.

Generally, consolidating defaulted student loans takes about 30 days.

Once you have consolidated your defaulted student loan, collections agents may no longer contact you. However, your credit report will still include the information about your default for up to seven years, meaning rehabilitation is the better option for borrowers who are worried about their credit history.

A borrower who is consolidating defaulted student loans will face fees up to 18.5 percent of the unpaid principal balance and accrued interest. But like rehabilitated loans, consolidated loans are once again eligible for benefits like deferment, forbearance, and loan forgiveness once the process is complete.

As with student loan rehabilitation, consolidation of a defaulted loan is a one-time opportunity. It will not be available to you again should you face another default.

  1. Pay off your student loans in full

A third option for getting your student loan out of default, whether it’s federal or private, is to pay your loan off in full.

Providing a full payment will wipe out your debt and stop any consequences of default, such as wage garnishment or tax offsets, in their tracks.

Of course, this approach is probably not possible for most borrowers, especially not for those are facing a steep amount of debt.

But if you can find room in your budget to make extra payments, take on a side hustle for more income, or even refinance your student loans for lower interest rates, you can work toward paying off your debt ahead of schedule.

How to choose the best option for your finances

When it comes to choosing between rehabilitation and consolidation, keep in mind that both options have pros and cons.

If you want to get your student loan out of default as fast as possible, consolidation could be the superior choice. Typically, it only takes about 30 days until you’re out of default, whereas rehabilitation requires months of repayment.

Rehabilitation, however, has an edge over consolidation when it comes to your credit score. After you rehabilitate your loans, your default will get removed from your credit report.

That said, your credit history could still show late and missed payments. Rehabilitation also might have slightly lower fees than consolidation — 16% as opposed to 18.5%.

Finally, remember that rehabilitation brings your old loans back from default, but consolidation essentially gives you a new, simplified loan.

If you have multiple loans, consolidating combines them into one loan with one monthly payment. This could make it easier for you to manage your debt and avoid default in the future.

In the end, both approaches accomplish your goal of getting your student loans out of default. Make sure to contact your loan servicer to work out an approach that will be most beneficial for your unique situation.

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