Student loans are a point of anxiety for many young adults and rightfully so. It is quite apparent that these borrowers are struggling; the default rate for students three years after leaving school is now an astounding 11.5 percent.
If a borrower opts to stop paying their student loans, the loan will eventually enter default. At that point, there are a variety of measures that can be taken by the lender, whether that’s a private lender or the federal government.
What It Means to Default on Student Loans
Delinquency is a term that refers to missing payments. A borrower is considered delinquent on a student loan after their first missed payment. A student loan account is delinquent until the missed payment is made up for, even if the next month’s payment is made on time.
If a borrower is more than 90 days delinquent on a payment, the servicer of the loan will typically report the delinquency to the major credit bureaus, which can lower a borrower’s credit score.
If a loan stays delinquent, it may go into default. The specific terms of when someone is considered to have defaulted on a loan varies depending on the terms of the loan. For example, with some of the federal student loan programs, if a borrower doesn’t make a payment for at least 270 days, the loan is considered to be in default. Private student loan lenders may have different terms, and a borrower may be considered in default sooner than they would with a federal student loan.
When a borrower defaults, different actions can be taken by the lender including:
- The balance of the loan may become due immediately
- The borrower may lose the opportunity to take advantage of forbearance or deferment programs
- The credit score of the borrower often goes down
- The lender may sue the borrower
Why You Can’t Refinance Loans in Default
Refinancing student loans refers to a scenario in which the borrower gets a new loan with a new, typically lower, interest rate. Federal and private student loans are eligible for refinancing and the result is one new private student loan.
While refinancing can save you lots of money, if your student loan is already in default, you more than likely can’t refinance it.
To refinance a student loan, lenders usually want to see proof of good income, as well as a strong credit score and repayment history. If someone has defaulted on a student loan, the lender has no reason to trust the borrower to make payments on the new loan.
Options for Dealing With Defaulted Student Loans
Since refinancing may not be a viable option once a borrower has defaulted on student loans, what options are available?
For federal student loans, there are two primary options. One option is called loan rehabilitation and the other is called loan consolidation. Loan rehabilitation is usually a process that requires several months to complete, while loan consolidation can happen more quickly.
If you rehabilitate a loan that was defaulted on, the default is taken off your credit history, but the late payments will still show as they were reported before the loan actually went into default. With consolidation, the default and the history of late payments stay on the borrower’s credit report.
Rehabilitation requires borrowers agree to make a certain number of reasonable and voluntary monthly payments. The amount of payments over the course of a period of time is usually equivalent to 15 percent of the borrower’s discretionary income divided by 12 months.
With federal student loans, a Direct Consolidation Loan may be an option as well. Under this plan, the borrower agrees to repay their new Direct Consolidation Loan under a payment plan based on their income.
With private student loans, options may be more limited and are dependent on the lender. Some lenders will allow for loan rehabilitation, but it’s rare. More likely with private student loans is negotiating a debt settlement. Some student lenders will work with borrowers to determine an amount they’re responsible for paying. When a settlement is negotiated, the borrower has to pay a smaller lump sum.
Borrowers should keep in mind that unless the default is removed from their credit history, their score is still going to be significantly impacted by these options.
Preventing Student Loan Default
Rather than trying to deal with student loan default after it happens, it’s better to be proactive and take steps before it gets to that point.
With federal student loans, there are more options to avoid default. For example, options can include temporarily postponing payments, which is called deferment. Forbearance is a period during which monthly student loan payments are temporarily reduced or suspended. You can learn more about these in our Deferment & Forbearance Guide.
There are federal consolidation loans available as well, which let borrowers combine multiple student loans into one new loan with an extended repayment term which will reduce the monthly payments. Similarly, borrowers may opt for an income-driven repayment plan that will cap monthly payments at a percentage of the borrowres discretionary income.
With private student loans, options like forbearance or deferment may be available, but it’s at the discretion of the lender, so be sure to contact them and see what options you have.