By now, it’s obvious that you will want to do everything possible to get out of default. Among other things, the default notation will be removed from your credit report, you will be eligible to apply for a deferment, and you will be eligible to take advantage of any flexible repayment options offered by your lender.
There are basically four ways to get out of default on federal student loans, all of which are discussed below.
If you have a federal health care loan, it is generally much easier to get out of default than with other types of federal student loans. By contrast, if you have a private loan, college loan, or state-funded student loan, it is generally much more difficult to get out of default. As with any type of commercial debt, you are in most cases obligated to pay what you owe, regardless of your tough financial circumstances. However, you can always contact your lender, the college’s financial aid office, or the state student loan office to inquire about any options.
Rehabilitation of loans–reasonable and affordable repayment plan
At one time, it was almost impossible to get out of default on federal student loans. However, when the student loan default rate peaked in the early 1990’s at 22% of all borrowers, Congress enacted legislation making it easier for borrowers to get out of default by making 12 consecutive reasonable and affordable payments. This requirement was later modified to 9 out of 10 consecutive payments paid within 20 days of the due date.
Under the reasonable and affordable repayment plan, you make 9 out of 10 monthly payments based on what you can afford while you still pay for your basic necessities. This is the most common and popular method to get out of default.
The guarantee or collection agency collecting your loan decides what is reasonable and affordable after considering your disposable income and your necessary expenses (e.g., housing, utilities, food, medical care, and daycare). Each repayment plan is determined individually. Be prepared to provide the appropriate paperwork showing your income and expenses such as bills, receipts, and pay stubs. After the guarantee or collection agency reviews your income and expenses, it makes a determination of what you can afford to pay each month.
No matter what type of collection efforts you are currently being subjected to (i.e. you can be in the middle of a lawsuit with the Department of Education), you are always eligible to request a reasonable and affordable repayment plan.
Contact the guarantee or collection agency immediately if you cannot meet the payment amount set by the agency. You have one shot at this repayment program. If you don’t make the required payments, you will not have another chance to get out of default this way.
When you have made 9 out of 10 reasonable and affordable payments, you will be out of default. Your credit report will be updated, and any reference to the default eliminated. Most important, you will be eligible to apply for a deferment, which is a temporary postponement of your loan payment based on a specific condition, such as unemployment. This can give you more breathing room and the opportunity to get your finances back in order before your payments must resume.
If you are not eligible for a deferment, the Department of Education or guarantee agency can sell your loan to a company on the secondary market, a process called loan rehabilitation. When your loan is rehabilitated, you will be put on a standard 10-year repayment plan, under which you pay a fixed amount every month for 10 years. Unfortunately, the required monthly loan payment under this plan will likely be much larger than what you were paying under the reasonable and affordable plan. If so, you may request one of several flexible repayment options now offered by many lenders. For example, you might consider a graduated plan where your payments start out low but increase over time, or an extended plan where the payments are spread over as many as 30 years, which results in lower monthly payments.
Consolidation of loans
To consolidate your loans, you combine several loans into one or you refinance your loans at a lower interest rate. This step eliminates your old loans and creates a brand new loan.
Some lenders may not consolidate defaulted loans. They may require that you make 12 consecutive reasonable and affordable payments and get out of default before allowing you to consolidate your loans.
This method is not nearly as popular as the reasonable and affordable payment method–your credit report is not completely cleared and most consolidation lenders require you to first make three monthly payments on your defaulted loans. In most cases, these payments will be quite high. There are other drawbacks to loan consolidation as a way to repay loans, such as an increase in the overall cost of the loan resulting from higher interest payments. The only advantage of loan consolidation is that it can be done in three months instead of twelve.
Compromise of loans
Though rare, a guarantee agency has the authority to compromise your debt, which means that it can accept less than the total amount you owe as full satisfaction of the debt. Rarer still is the guarantee agency that advertises this option. If you want to learn about it, you’ll have to take the initiative and ask.