Take out loans to pay for college: check. Graduate: check. Get a high-paying job and pay off those student loans … not so much.
Unfortunately for many college grads, that last part doesn’t always work out as planned. With the country owing a total of $1.4 trillion in student loans, it’s probably not surprising that more than 1.1 million people defaulted on their federal direct loans for the first time last year, according to the Consumer Federation of America. That brings the total number of borrowers in default to 4.2 million.
But what actually happens if you default on your student loans? The consequences can be pretty severe.
1. Your loans will go into collection.
Once you enter default on a federal student loan, your loans will be assigned to a collection agency and the entire balance becomes due immediately — along with interest, explains Matt Ribe, a student loan counseling expert with the nonprofit National Foundation for Credit Counseling. That means you’ll be on the hook for the full amount of your loan, unless you go through a rehabilitation process (more on that later).
If you have federal loans, you’re considered in default if you haven’t made a payment in 270 days, or about nine months. For private loans, it can really vary by lender, explains Fred Amrein, a financial planner and founder of College Affordability LLC, a college financial software company. But it’s likely you won’t have the same flexibility in options for avoiding default as you would with a federal student loan, and the lender may start going after repayment in a shorter period of time.
2. You won’t be able to take out additional federal student loans.
Once in default, you won’t be able to borrow additional federal student loans, plus you’re also no longer eligible for federal deferments, forbearances or different repayment plans unless you go through rehabilitation. Rehabilitation entails entering into a payment plan to demonstrate your willingness to pay back the loan, Ribe says.
Basically, if you enter rehabilitation, you’re agreeing in writing to make nine consecutive payments of a “reasonable amount” as set by your loan holder. This amount will likely be 15% of your annual discretionary income, divided by 12. Once you’ve made these nine payments, you’re no longer considered in default, and the default itself will be removed from your credit history.
You can also consolidate a defaulted loan into a federal direct consolidation loan, which essentially uses a new loan to pay off your old ones. If you go this route, you have to 1) make three consecutive on-time payments on your defaulted loan before you can consolidate it; and 2) agree to repay the new consolidated loan under an income-driven repayment plan. Also, you can’t just turn your defaulted loan into a new consolidated one; you need at least one other eligible loan to consolidate it with. Consolidation also won’t remove the default from your credit report the way rehabilitation will.
Speaking of credit reports …
3. You’ll get majorly dinged on your credit report.
It’s not just a default that brings your credit score down. The missed payments leading up to the default will also be reported to a credit bureau, as will any accounts in collections. Basically, if you’re delinquent on any of your accounts and it has been reported to a credit bureau, that mark won’t be removed from your credit report for seven years.
Although there’s no definitive formula for knowing how much a default will bring your score down. According to myFICO.com, even one 30-day delinquency on a payment can drop 60 to 80 points from someone with a 680 score; someone with a 780 could see a drop of 90 to 110 points.
The lower your credit score and the more delinquencies you have on your report, the more of a risk you appear to future potential lenders. This could affect the type of interest rate you pay and the lending terms you could get on everything from an auto loan to a mortgage to a credit card.
4. Your wages could be garnished.
If your student loans go into default and you don’t make a plan to pay them back, it’s possible your employer may have to withhold part of your paycheck and send it to the loan holder in order to start repaying your loans.
Sounds extreme, right? Well it is — but it’s entirely possible. And it’s not just your wages that could be affected; the government can also garnish any federal benefits, like a tax refund or Social Security payment. “Essentially, they are trying whatever method they can to take money from you to apply to your loan balance, because at that point, the assumption is the borrower is not going to be engaged in the repayment process,” Ribe says.
Private lenders may also try to garnish your wages by filing a lawsuit against you, assuming the state you live in doesn’t have laws that protect against wage garnishment. Although it’s usually a last-resort move, it could lead to a lengthy court battle.
5. Your co-signer will be on the hook for your balances.
If you had to get a co-signer in order to receive a loan, then you’re putting that person’s finances and credit on the line, too, when you default.
Rob C., a New York City-based analyst, knows that all too well. He co-signed his daughter’s $15,000 private student loan, and when she stopped making payments, the lenders went after him.
“By the time the institution got in touch with me, she was seven months behind,” he says. “They were hours from a full default. I worked out a repayment plan for the back months over the next three months and brought her up to date.”
It was a disappointing experience for Rob, considering his daughter knew about his own struggles with student debt — both he and his wife had defaulted on their student loans when they were younger and had to go through the rehabilitation process to get back on track.
He and his wife are still making payments on their loans while continuing to do so for their daughter so she doesn’t come close to default again. “I totally thought she was covering this, but apparently she was not,” he says. “I’m paying for my daughter’s education, but I haven’t paid for mine yet. These things just snowball to where there’s going to be a weight around you for 25 years, and if you’d just stopped and taken the time to find out what your options were, there might have been something better for you.”
The Lesson? Do Whatever You Can to Avoid Default
The personal and financial repercussions of default can be so costly that it’s better to investigate all your options before reaching that point.
Once you realize you’re in danger of defaulting, Ribe and Amrein both advise reaching out to your loan servicer to explain your financial situation, whether it’s a sudden loss of income from being laid off or having to pay large, unexpected expenses.
“[The lenders] will work with you because they don't want to see you default either,” Amrein says. “They want to get their money back.”
On the federal side, consider looking into deferment or forbearance temporarily, suggests Ribe, who says this could be a good short-term solution (though these options are not unlimited and borrowers may have only a certain number of months where they are eligible).
If you know your ability to make your payment isn’t just a short-term situation, you may have to look into changing your repayment options or opting for income-based repayment plans, which will base your monthly payment on a percentage of your discretionary income. If you work for a nonprofit or in public service, it’s also worth checking to see if your loans are eligible for any future loan forgiveness programs (although there has been controversy of late over whether those programs will come to fruition).
Meanwhile, private lenders often have modification programs if you're finding yourself struggling, Ribe says. “Those options vary by lender, but many will work with the borrowers to find an option that makes sense,” he says. This could include extending your repayment terms, reducing interest rates or even adopting their own deferment or forbearance options.
If you have federal loans and think you can get a lower interest rate with a private lender, you could also consider refinancing your public loans into a private one — just bear in mind you’d lose any of the benefits and repayment flexibility that can come with federal loans.
The bottom line? Don’t assume your lender isn’t willing to meet you halfway.
“You can duck your student loans but, eventually, they're going to come back. It would have been better, cheaper and easier for us to have worked out anything we could have with the servicing institution," says Rob C. of his and his wife's own default experiences. "I think at one point they even said, ‘We would have been willing to take $20 a month for a while.’ Your best bet is to try to work it out as quickly as possible.”