What Happens When You Default on Student Loans
If you’re recently out of school, and you have student loan debt, you need to understand what happens when you are delinquent on a student loan and what happens if you default.
And you need to do everything in your power to make sure that neither of these things happens.
If you miss a payment, you are delinquent. You’ll stay delinquent until you catch up on the payment you missed. Even if you miss just one payment and begin making regular monthly payments again, you’ll still be delinquent on your student loan until you catch up with the past due amount.
That delinquency will soon be reflected on your credit report.
Any delinquencies on your credit report will impact your credit score, and it will make it much more difficult for you to get approved for credit in the future. That includes everything from personal loans to credit card applications to car loans, mortgages and future student loans.
Your history of prompt, reliable, on-time payments to all creditors is the single most important factor in your credit score, according to the Fair, Isaac Corporation, the data services firm that provides the credit scoring products most commonly used by U.S. lenders in most industries.
Your credit score isn’t just something lenders look at: Many landlords, most property managers and more than half of employers will pull a credit report on a new job applicant or rental applicant. Bad credit can get you turned down for job opportunities, and even make it harder for you to find a place to live.
A 30-day delinquency on your credit report is not great, and lenders look very negatively on any 60-day delinquencies or more. It doesn’t take too many of these before you’re a subprime borrower, and not eligible for favorable terms or desirable apartments. And you’ll almost certainly have to clear up any delinquencies before you can get funded on a mortgage if you try to buy a home.
Delinquencies on your credit report could hobble your career and lifestyle prospects right out of the gate.
Federal student loan services will report you as delinquent to all three major U.S. consumer credit bureaus – TransUnion, Equifax, and Experian – generally after 90 days. Private lenders usually won’t give you that much time.
Default is one of the worst marks you can have on your credit report. In some ways, it’s more damaging than bankruptcy. At least if you’ve had a recent Chapter 7 bankruptcy (liquidation) on your credit report, lenders will know that you can’t declare a Chapter 7 again for another seven years.
With a default on your record, future lenders have no such assurances: You could declare a Chapter 7 tomorrow and new lenders could be left holding the bag.
So it’s important to avoid defaulting on a student loan agreement.
But if you fail to make payments for a long enough period of time, the lender will eventually report a default to the credit bureaus, and that’s going to be a serious black mark on your credit report.
The timeline from the missed payment to default status varies based on the type of loan. For the William D. Ford Federal Direct or the Federal Family Education loan programs, you can expect them to report you as being in default if you fail to make payments for 270 days, or about nine months, without a forbearance in place.
For Perkins loans, you may be reported as having defaulted after your first missed payment.
If you are having difficulty making an upcoming payment, or you are falling behind, immediately contact your student loan servicer – or your school’s financial aid department, if the loan in question is a Perkins loan.
You may be able to request a deferment or forbearance, or you may be able to enroll in an income-based repayment plan, in which your required student loan payments are capped at a more affordable percentage of your income.
Note that with some lenders, a deferment or forbearance at any point in the life of the loan could disqualify you for any request to release a co-signer from your loan.
Consequences of defaulting on a federal student loan
- Your school or servicer will enter your loan as defaulted in the National Student Loan Data System.
- You’ll lose eligibility for further federal student aid. But this is a no-brainer.
- Your lender or servicer will report your default to credit bureaus. This will harm your credit score and your ability to get further loans, such as mortgages, car loans, and credit cards. It may also make it harder to rent an apartment, get a job or even open a checking account.
- You’ll face collection costs. For most federal loans, the government may deduct 20 percent from your payment in collection costs before a dime goes to principal reduction. For Perkins loans, the collection costs are even higher. Up to 30 percent of the total amount, including principal, interest and late fees, for a first attempt. They go up to 40 percent on a second attempt. If your case involves litigation, you may be looking at 40 percent in collection costs.
- The government may garnish your wages. Uncle Sam can garnish up to 15 percent of the borrower’s disposable pay without a court order.
- The U.S. Armed Forces will bar you from joining.
- The government can deduct up to 15 percent of Social Security benefits in order to repay defaulted student loans. This includes disability benefits.
- The U.S. Department of Education may deduct collection charges of up to 20 percent of each payment.
- The federal government may coordinate with your state to block you from renewing your professional license. This may include a nursing license, license to practice medicine or law, a teaching license, psychologist’s license, physical therapy or occupational therapy license, and in many states, any professional license. This extends to barbers, cosmetologists, insurance licenses, locksmith licenses, veterinarians, social workers, accountants – anything. Details vary by state.
- If you live in Montana, Iowa, and Oklahoma, your driver’s license may get suspended.
- You could lose eligibility for VA or FHA mortgages. These two programs allow you to buy a home with very little or nothing down (FHA requires 3.5%). FHA allows people to buy homes with credit scores as low as 500. This is a much lower threshold than other lenders will consider.
- Won the lottery? Not so fast. The federal government can intercept some state lottery payments to pay off student loans in default.
The federal government can and occasionally does file suit to seize the personal assets of borrowers in default. Once they have a judgment and an order, they can levy your bank account. They can also place a lien on any homes you own.
Can I Settle?
With private student loans, you may be able to get a favorable settlement. Without a federal guarantee, lenders are generally looking to limit their losses and will make the best deal they can.
You must report the amount forgiven as ordinary income, and pay taxes on it.
With federal loans, you probably won’t get a settlement offer. Absent a documented total and permanent disability, The U.S. Department of Education is not likely to settle for less than the full loan amount.
Rehabbing a Defaulted Loan
In some circumstances, a borrower in default can rehabilitate a loan. This will enable you to climb out of default, and remove the default notice from your credit report. You won’t have to pay the entire loan balance on the spot.
You only get to do this once, though.
See our article here.
What To Do if You’re In Default or About to Default
The first thing to do is contact your lender or servicer and tell them you’re having trouble making payments, and you’ll keep them updated. Send what you can, when you can, and keep them informed. If you’re in regular touch with the lender or servicer, they are less likely to push court action. This can help prevent more severe actions that take away your choices such as wage garnishment.
Generally, garnishments happen to people who ignore the lenders – not the ones who keep them informed and send regular payments – even if they’re behind.
Next, get help from a student loan counseling professional. They may be able to help you apply for an income-driven repayment plan that makes more sense for you, or help you develop a roadmap for yourself to get you there.
In some cases, you might want to consolidate your student loans to get a smaller and more manageable payment. But when you consolidate a federal student loan and convert it to a private loan, you may give up certain rights and privileges. That’s why it’s important to work with a debt counselor with expertise specific to federal student loans. Not every debt counselor is going to have the expertise you need. For example, they could give you advice that, if followed, will accidentally cost you eligibility for a loan forgiveness program down the road. Or they could cause forgiven loan balances to be taxable when they wouldn’t otherwise be taxable. Or prohibit you from taking advantage of federal loan privileges such as forbearance and deferment in the future.
Jason Van Steenwyk is an experienced financial industry reporter and writer. He is a former staff reporter for Mutual Funds, and has been published in SeekingAlpha, Nasdaq.com, NerdWallet, Value Penguin, RealEstate.com, WealthManagement.com, Senior Market Advisor, Life and Health Pro and many other outlets over the past two decades. He is also an avid fiddle player and guitarist. He lives in Orlando, Florida.