Understand the Consequences of Student Loan Default
Recently, the New York Federal Reserve released some alarming information on student loan defaults that indicated up to a quarter of all borrowers from the last nine years have defaulted on their loans. The report also showed that up to 37 percent have missed at least one payment.
These numbers are much higher than the three-year cohort default rate measured and published annually by the Department of Education and show a growing trend of borrowers who are in need of information on how to use the lower payment and other options available for federal student loans.
Most struggling borrowers know that their loan is in default or at risk for going into default, so some of the consequences such as tax refund and wage garnishment may not be a surprise. But there are other consequences of defaulting on your federal student loan you may not be aware of.
Learn to [start student loan repayment off right from the first payment.]
There Will Be Fees
If you ask federal student loan borrowers why they defaulted on their loans, nearly all would answer that they were in financial difficulty or couldn't afford their payments. For a defaulted loan, it only gets worse.
First, the entire balance of the loan is due and payable immediately. There are no more monthly bills and no more lower payment options, as the loan loses eligibility for these benefits by being in default.
Second, any interest that was outstanding at the time of default will be capitalized, or added to the principal. This will increase your overall loan balance and cause you to have interest charged on interest, which is certainly not ideal.
The collection costs may be the biggest blow. Collection costs vary for different types of loans. For Perkins loans, these can be as high as 40 percent. For federal Stafford, PLUS, and consolidation loans, collection costs are as high as 24 percent ,but can be discounted to 18.5 percent if the borrower consolidates out of default or as low as 16 percent if the borrower rehabilitates the loan.
These costs can add up quickly. Let's say you defaulted on your $25,000 federal loan after a year. Th is example loan has a 5 percent interest rate, so right away your loan holder will add $1,250 to the balance in capitalized interest, plus any late fee amounts they may have charged you along the way. Now add the 24 percent collection cost of $6,300, and your $25,000 balance has grown to $32,800 in a year.
These collection costs are set in federal law and regulation, so in most cases, there's not a lot of wiggle room to negotiate these fees. Some loan holders will reduce these fees if you agree to pay the defaulted loan in full.
See [how late student loan payments affect your credit score.]
Expect Garnishments and Lawsuits
Federal student loan holders and the Department of Education can garnish your tax refund without any type of court order or legal action, although they will notify you ahead of time and give you the opportunity to appeal or resolve the default. If you filed your taxes with a spouse, their portion of the refund will also be garnished and put toward your defaulted student loan.
If having the refund garnished is a hardship, the borrower can try appealing to the loan holder to have some or all of it returned. Success in this case varies. The non-borrower spouse can also file an injured spouse claim to have his or her portion of the refund returned.
In general, defaulted student loans will be certified for tax offset after months of attempts to resolve the loan with the borrower with little or no response. Once a loan is certified for offset, it's rare to have it removed unless and until the loan is either taken out of default or paid in full. They can also garnish your Social Security and other benefits.
Wage garnishment is another tool often used to collect defaulted student loans. Affected borrowers are sent notification at least a month prior to the beginning of the garnishment and given the borrower an opportunity to appeal. Loan holders, with some exceptions, may garnish up to 15 percent of a borrower's wages.
If these tactics prove unsuccessful, the U.S. Department of Justice may decide to sue the defaulted loan borrower for payment. This action can add significantly more fees and put your assets at risk , but is rarely taken due to the other tools the government has to collect these loans.
Get the [facts behind the student loan bankruptcy myth.]
Other Consequences
One of the more well-known penalties of student loan default is being unable to take out additional financial aid. This can be sort of a no-win situation if you were in financial difficult y in the first place because you did not complete your credential or you need an advanced degree or certificate. Defaulting can also tank your credit score.
Some state boards are even allowed to revoke or suspend a license to practice certain professions in their state for borrowers with defaulted federal student loans. This can include medical professionals, teachers, state officers and attorneys.
Solutions and Fixes
If you're having financial difficulties, call your loan holder. If the loan isn't in default yet, there are many lower payment, deferment and other options available that can help prevent that from happening -- but you need to reach out.
Most of the defaulted borrowers that the Student Loan Ranger encounters could have prevented the default from happening if they'd just allowed their loan holder, or other industry advocate, to work with them.
If you have already defaulted, you can resolve the default through rehabilitation, consolidation or by paying the loan in full.
Betsy Mayotte, director of regulatory compliance for American Student Assistance, regularly advises consumers on planning and paying for college. Mayotte, who received a B.S. in business communications from Bentley College, is a frequent contributor to ASA's SALT Blog; responds to public inquiries via the advice resource "Just Ask;" and is frequently quoted in traditional and social media on the topics of student loans and financial aid.
