You’ve been repaying your student loans faithfully for five years but, all of sudden, things have taken a financial turn for the worse. You’ve been laid off from your job, your car needs repairs, and you suddenly find yourself with unexpected medical bills. In short, you are facing a serious cash flow shortage.
Some borrowers run into financial difficulties at one time or another in the course of repaying their student loans. If you find yourself in this position, don’t despair. Nearly all lenders offer certain options to help you through temporary cash flow jams.
The primary way to temporarily postpone the repayment of your student loan is to request either a deferment or forbearance from your lender. If this is not possible, you can try to have your student loan permanently canceled. If this too is unsuccessful and you can’t otherwise negotiate with your lender for a reprieve in your payments, you will be in default on your student loans. Each of these subjects is discussed below.
You will need to communicate with your lender about your financial situation as soon as possible to avoid becoming delinquent, or worse, defaulting on your student loans. The worst thing you can do is to avoid the situation. The sooner you communicate with your lender, the easier it will be to get help in your repayment efforts.
As a last resort, you may decide to file for bankruptcy. However, be aware that it is very difficult to have student loans discharged in bankruptcy.
Loan deferment or forbearance
Although many borrowers think of a deferment and forbearance as one and the same, they are different options.
A deferment occurs when your lender grants you a temporary reprieve from paying your student loan based on a specific condition that prevents you from repaying the loan. Such a condition may include unemployment, temporary disability, performing selected community service work, a stint in the Peace Corps, or a return to school on at least a half-time basis. Check with the holder of your student loan to learn exactly what deferment conditions are allowed for your loan type. In most cases, the government pays the interest on your loan during deferment periods, so your loan balance does not increase.
A forbearance occurs when your lender, at its discretion, grants you permission to reduce or stop your loan payments for a set period of time. In all cases, interest continues to accrue on your loan during forbearance periods. Thus, a deferment is usually the better option (if available) because of the possibility that Uncle Sam will pay the interest. However, a forbearance is usually easier to obtain than a deferment because it is not governed by the types of loans you have or the date you obtained them.
A forbearance may be allowed when your loans are in default. However, a deferment is never allowed when your loans are in default. The granting of a forbearance is generally at the lender’s discretion.
The deferment or forbearance period is usually 6 months, but in some cases it may be as long as 9 or 12 months. Most lenders limit the total number of deferment or forbearance periods you may have over the course of your loan. For instance, a lender may limit you to four 6-month deferment periods over a 10-year student loan.
To obtain a deferment or forbearance, you need to apply for one with your lender. They are never automatic. This means obtaining the appropriate paperwork from your lender, completing the application carefully, attaching any required supporting documents, and following up to make sure your request has been processed correctly.
Keep a copy of the deferment or forbearance application for your records, along with the lender’s written approval of your request.
After you have obtained a deferment or a forbearance, you may need to reapply from time to time to keep it. This is called recertification. Basically, you will have to provide evidence that the condition on which your deferment or forbearance was based still exists. For instance, an economic hardship deferment may be available for up to three years, but you might have to prove your eligibility every 12 months.
If you need to recertify, your lender should send you a notice reminding you about a month before your loan payments are set to resume. However, even if you don’t receive a notice, you are still responsible for keeping track of when your next payment is due and taking any appropriate steps to postpone the payments again if necessary.
A cancellation means you do not have to repay your student loans at all because a specific condition exists. The loan is permanently wiped off your list of financial obligations. Similar to a deferment, a cancellation is based on the types of loans you have and when you borrowed the money. In some cases, only a partial cancellation is available.
It is not easy to qualify for a cancellation. Some examples of when a cancellation may be granted are upon the death or permanent total disability of the borrower, or if the borrower takes a job teaching needy populations in certain geographical areas. Check with the holder of your student loan to find out the circumstances under which you can cancel your loan.
To cancel a student loan, you will need to complete the appropriate paperwork from your lender. It is likely you will need to supply outside documentation to support your application, such as a statement from your doctor describing your total disability.
If you are unable to obtain a deferment or forbearance from your lender, do not meet the requirements for cancellation, and are still unable to repay your student loans, then you will be in default. Generally, you are considered to be in default on your student loan when your loan payments are at least six months overdue and your lender has concluded that you do not intend to repay the loan, either because you have ignored all requests to contact your lender or because you have moved and left no forwarding address.
Being in default on your student loans is different than being delinquent on your student loans. If you have missed only one or two monthly payments, you are considered delinquent on your loans. This means you may receive a phone call or a letter about your intent to repay. Once you have failed to make payments for 90 days, you are generally considered to be in default.
Default is treated as a serious matter. When your loan is in default, the lender will typically pass it on to either a collection agency or a guarantee agency. These agencies are authorized by law to take aggressive action to get you to make your payments.
What types of collection efforts can you expect if you are in default?
Initial collection efforts
When you are in default on your student loans, you will likely receive initial collection attempts in the form of phone calls and threatening letters. If the holder of your loan does not have your current address, it may try to locate you by calling relatives, friends, neighbors (even your old landlord) and posing as a long lost friend. In addition, the loan holder may comb the post office, state motor vehicle department, voter registration records, utility companies, credit bureaus, and federal government records for your last known address.
Besides initiating phone calls and letters, your lender will likely notify national credit bureaus of your default. So if you apply for a mortgage, a new credit card, or an insurance policy, your application may be rejected.
More serious collection efforts
If you ignore any initial collection efforts, chances are good your lender will attempt more serious collection efforts. The four most common weapons are assessing collection fees, intercepting your tax refund, garnishing your wages, and suing you.
A collection fee of approximately 25% is added to the balance of your outstanding loan amount. In some cases, the collection fee may be reduced if you take steps to get out of default, such as entering into a repayment plan or consolidating your loans. Other collection fees can include mail and phone costs and fees for reporting information to credit bureaus.
Collection fees can greatly increase the overall cost of your student loan. They are the main reason to communicate immediately with your lender when you are facing financial difficulties and to avoid default at all costs.
Tax refund interception
The IRS can intercept your income tax refund until your defaulted student loans are paid in full. In fact, this is one of the most successful methods of collecting defaulted student loans.
Your tax refund can be intercepted only if your loan is held by a guarantee agency, the Department of Education, a collection agency working for the Department of Education, or a guarantee agency. So if the holder of your loan is your college, a private lender, a loan servicer, or a company on the secondary market, your tax refund cannot be intercepted by the IRS.
You can avoid having your income tax refund intercepted by determining how much you expect to owe in taxes and having your employer withhold just the right amount to cover it.
Besides losing your federal tax refund, you may stand to lose your state tax refund as well. Several states now intercept state tax refunds for forwarding to the Department of Education. Many states deny professional licenses necessary to practice certain professions, such as medicine or law, to borrowers in default on their student loans.
Under current law, the Department of Education and guarantee agencies are authorized to garnish up to 15% of your wages if you are in default on your student loans. They do not have to sue you first, as is the case necessary with other types of debt.
There are rules governing the wage garnishment process. At least 30 days before the garnishment will begin, the Department of Education or guarantee agency must notify you in writing of the amount you owe, how to enter into a repayment schedule (a step that would stop the garnishment), and how to request a hearing on the proposed garnishment. To stop the garnishment, you must respond to the notice in writing within 15 days of receiving it or by following any instructions contained in the notice. Otherwise, a wage garnishment order will be sent to your employer.
As with a tax refund interception, wage garnishment is unavailable to colleges, private lenders, loan servicers, and companies on the secondary market. These institutions must sue you first and obtain a judgment against you before they can attempt wage garnishment.
There is no longer a statute of limitations (a time limit for when you can be sued) on student loan collection lawsuits. So, the Department of Education has forever to sue you to collect your student loans, though this is the least popular method of all the collection efforts.
In reality, you are likely to be sued only if the amount the Department of Education or guarantee agency can obtain from you is more than the cost of litigation, and you have assets that can be taken to satisfy all or a sizable portion of your debt.
What can you do to get out of default?
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.
Write-off of loans
If you believe there is no way you will ever be able to repay your loans and you don’t qualify for a cancellation of your loan or a compromise, you can ask the guarantee agency or the Department of Education to write off your loans. Circumstances under which you might find it impossible to repay your student loans include a long period of unemployment with no job prospects whatsoever, or a chronic illness that prevents you from working.