A report completed by the American Enterprise Institute looked into what happens after student borrowers default on their loans.
About a million borrowers default on their student loans every year. And there is a lot of data about what type of borrower is most likely to default on their loans or what the most common causes of default are. But there isn’t a lot of existing data on what happens after borrowers default on their loans.
A report from the American Enterprise Institute examined exactly that, and many of the findings were surprising. Overall, the report found that there is no common path that most borrowers take after defaulting on their federal student loans.
Federal student loans account for 90 percent of the student loan market. Borrowers are considered to be in default after failing to make an on-time payment for 270 days. Once a borrower defaults on their federal student loans, the loan is assigned to a collection agency to collect on the debt. It might also result in the garnishment of tax refunds or paychecks.
The report showed that most borrowers who default on their student loans will eventually resolve their defaults. A year after defaulting, 13 percent of most borrowers have brought their account back into good standing. By five years, this figure increases to 62 percent.
There are common characteristics that can be found among individuals who are more likely to default on their loans. For instance, individuals who drop out of college or attend for-profit schools are more likely to default on their loans. But none of these characteristics seems to indicate whether a borrower will exit default.
For instance, college completion status doesn’t seem to have any bearing on whether a borrower will exit default. The best indicator seems to be the loan balance at the time of default. Seventy-four percent of borrowers who owe less than $5,000 exit default within five years. Meanwhile, 59 percent of borrowers who owe more than $20,000 will exit default within five years.
The report also showed that many borrowers who default on their loans later repaid their loans in full. In fact, 31 percent were able to exit default by making a full loan payment within five years.
Many borrowers seem to be motivated to exit default so they can take out more student loans, according to the study. Within five years of exiting default, 30 percent of borrowers have taken on more student loan debt. And 25 percent will default again on either new or existing student loans.
For borrowers who are worried about defaulting, there are several steps they can take. Borrowers should contact their student loan servicer to discuss their options first. Income-driven repayment plans, loan deferment, and forbearance could all be possible options to help avoid default.
For borrowers who have already defaulted, it is possible to manage the situation and find a way to exit default. Loan rehabilitation programs are a good way for borrowers to get out of default and back in good standing with their servicer. Borrowers can also look into refinancing or consolidating their existing loans. However, bankruptcy is one option that is not available to most borrowers.