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Federal student loans are considered to be in “default” after 9 months of the borrower not making payment. Obviously, being in default on your federal student loans can have dire consequences. In addition to affecting your credit and ability to take out other loans, the federal government has enormous powers of collection including administrative wage garnishment, social security offsets, and tax refund intercepts to name a few.
Once in default, there are generally only a handful of options a borrower has to get out of default – (1) settlement, (2) rehabilitation, and (3) consolidation.
Under the settlement option, a borrower must pay off the amounts owed – principal and interest. Theoretically, a borrower may be able to negotiate a reduced payoff amount but given the enormous collection powers the Department of Education has to recover the full amount, it is very difficult and unlikely and borrowers should expect to have to pay the full amount owed within 90 days.
Under the rehabilitation option, a borrower must make 9 payments within 10 months. The payments are typically equal to 15% of a borrower’s discretionary income and must be arranged through the debt collector. After the 9th payment is made and the rehabilitation is completed, the borrower resumes their normally scheduled payments.
Under the consolidation option, the borrower can simply consolidate their defaulted loans and pick an Income Driven repayment plan. An Income Driven repayment plan removes the default and allows the borrower to make a payment based on their family size and income. The consolidation essentially acts like a refinance of the defaulted loans.
Details and more information on each option may be found on the Department of Education’s website here.
At StudentLoanify, we focus primarily on helping borrowers consolidate their loans and select an Income Driven repayment plan. That’s because for the vast majority of borrowers, this is the best, easiest and most sustainable option. In fact, in a recent report by the Consumer Financial Protection Bureau, the CFPB found that “[b]orrowers who did not enroll in [an Income Driven Repayment Plan] were five times more likely to default for a second time.” The CFPB went on to find that while [Income Driven Repayment Plans] “should ensure payments remain affordable and repayment success is possible over the longer term…a series of administrative, policy and procedural hurdles may limit access to [such plans]” particularly after completing a loan rehabilitation. As evidence, the CFPB pointed to the fact that fewer than 2 percent of borrowers who complete a rehabilitation enroll in an Income Driven repayment plan at the completion of the rehabilitation and nearly one-third of borrowers find themselves back in default within 24 months. In short, the CFPB concluded that consolidations and Income Driven repayment plans produce better outcomes. For more information about the CFPB’s report, see here.
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