Home > News > A New Hope for Student Loan Defaulters

Comments 8 Comments
Advertiser Disclosure


A change to the federal student loan program this month presents a huge opportunity to borrowers who have defaulted on their loans from the government. Loan rehabilitation allows borrowers to return to current repayment status, access the benefits offered to borrowers in good standing and have the default removed from their credit history. With changes that went into effect July 1, that process became much more accessible to struggling borrowers.

What Is Student Loan Rehabilitation?

A federal student loan borrower fails to make a payment for 270 days, the loan goes into default, which triggers a wave of consequences that include losing your eligibility for federal student aid; losing eligibility for deferment, forbearance and repayment plans; having your loan sent to a collections agency; wage garnishment; and several other unenjoyable things.

Your credit standing will take a severe hit, which will take years to correct, and you only have three options for getting out of default: repay the loan, consolidate the loan or enter loan rehabilitation.

To rehabilitate a Direct loan or FFEL Program loan, you must make nine of 10 payments deemed “reasonable and affordable” by you, the Department of Education and the debt collector. (For a Perkins loan, you need to make nine of these payments in a row.) Once you’ve done that, a lot of good things happen: You once again have access programs like student loan deferment and income based repayment (IBR), and the default status is removed from your credit history (though delinquencies predating the default will remain) — that’s huge for your credit standing. You’re also not going to have to deal with wage garnishment anymore.

You need to be very careful, though: Outstanding collection fees (18.5% of the loan balance) will be added to your principal, meaning your loan payments could be much higher than they were when you defaulted, so it’s up to you to set up an affordable payment plan. Rehab is a one-shot deal, so if you default again, the option is no longer available to you.

What the Changes Mean for Borrowers

In its previous state, the rehab program had some hangups. The biggest issue had to do with the debt collectors trying to recover the defaulted loans.

“Debt collectors demanded a payment based on a commission payment, and they only took a commission if they took a payment of 1% or more of the loan,” said Joshua R.I. Cohen, a Connecticut attorney who calls himself “The Student Loan Laywer.” For example, if you had a $50,000 loan, the collector would demand a $500 payment for rehabilitation (on top of any involuntary wage garnishment), even if that amount exceeded 15% of the borrower’s discretionary income, which determines income-based repayment. Rehab was, in a word, unaffordable. For five years, Cohen has been filing lawsuits against collectors for not offering affordable payments.

Debt collectors were also not obligated to discuss loan consolidation with debtors, so rehab seemed like borrowers’ only option.

Now, borrowers should know they can use the income-based repayment benchmark to determine their “reasonable and affordable payment.” If the amount a defaulted borrower is supposed to pay on a 15% income-based repayment schedule is still unaffordable, the borrower can negotiate a lower payment. After five on-time payments, borrowers can ask to have their wage garnishment suspended (making it easier to continue the rehabilitation), and if they successfully complete their nine rehabilitation payments, the wage garnishment will be permanently removed.

“With this it becomes much more reasonable to switch from being in default with wage garnishments to having a more normal status,” said Mark Kantrowitz, Senior Vice President & Publisher of Edvisors.com. “That ultimately will benefit the lender, because oftentimes being in default on the loan causes all kinds of financial difficulties for the borrower that make it harder for them to pay.”

Having a default on your credit report will hurt your credit scores, and having poor credit makes other loans more expensive by way of higher interest rates. That in turn leaves the borrower less money to put toward the defaulted loan.

How to Get Out of Default

Consolidation is a faster way out of default than rehabilitation, but it doesn’t benefit your credit standing like rehab does. The added collection fees certainly aren’t a positive aspect of rehabilitation, but it may be worth the advantages.

Figure out what your monthly income-based repayment amount would be (there are calculators online to help with that), then contact the collector to start the process. If you successfully rehabilitate your loan, you’ll want to apply for income-based repayment so you don’t end up in the same predicament that landed you in default in the first place: unaffordable monthly payments. With IBR, any unpaid balance after 25 years of repayment will be forgiven.

It’s not like this is the panacea to the nation’s problem with student loan debt. Many still consider the system broken.

“The fact that I exist, I run a law firm that right now only deals with student loans, that tells you there’s a problem with the industry,” Cohen said.

Mitch Weiss, a finance professor at the University of Hartford and a Credit.com contributor, pointed out that these relief programs shouldn’t only be available to borrowers as far off the rails as those in default.

“If you have a borrower who has missed two or three payments, it’s unlikely you’re going to get that back to be current,” Weiss said. Default, 270 days past due, amounts to nine missed payments, meaning the borrower has probably long-passed the point of catching up, but fees and interest continue to add up before that borrower hits default. “There is something fundamentally wrong with the loan servicing process that borrowers are allowed to become so delinquent. The remediation programs that exist should not be exclusive to those that are so severely past due.”

Despite his issues with loan rehabilitation, Weiss said it’s “an OK option” for struggling borrowers. Consumers who have defaulted on their student loans should take the opportunity seriously, because getting the default off their credit report can make a huge difference in other areas of their finances. You only have one shot at it, though, so make sure you make a plan to afford your loan payments once you’ve emerged from default.

If you’re concerned about how your student loan payment history is affecting your credit, it’s a good idea to check your credit reports regularly to make sure they’re accurate, and to monitor your credit scores. This way you can get a clear picture of your credit situation, and begin to put together a plan to get your credit back on track. You can get your credit reports for free once a year through AnnualCreditReport.com, and you can use free tools through Credit.com to check two of your credit scores every month, and get an overview of what’s affecting them.

More on Student Loans:

Image: mj0007

Comments on articles and responses to those comments are not provided or commissioned by a bank advertiser. Responses have not been reviewed, approved or otherwise endorsed by a bank advertiser. It is not a bank advertiser's responsibility to ensure all posts and/or questions are answered.

Please note that our comments are moderated, so it may take a little time before you see them on the page. Thanks for your patience.

  • Adrian Evans

    Hi, is there any way if you have defaulted on the loan and consolidated and rehabilitated the student loans once already to get the loans out of default?

    • http://blog.credit.com/ Kali Geldis

      Hi Adrian —

      Unfortunately, student loan rehab does have some restrictions and you may not be able to use that program a second time to get out of default. Another option, though depending on your total debt, this may be a while off, is to pay back the loan in full, according to the Department of Education. You can call your student loan servicer to see if there are any other options that may be available to you.

  • Maria

    So I got into a bad situation and was not able to pay my student loans in time, so they garnished my wages. They have been paid in full as of 2006, but they are still on my credit report! Should I be disputing this or does it take longer because it was garnished?

  • kim

    I have paid off my student loans, but they are still on my credit report…how can i have them removed from my credit reports?

    • http://www.Credit.com/ Gerri Detweiler

      Your student loans will still be reported for seven years if the information is negative, and indefinitely if the information is positive. However, if you paid them off the balances should be updated to show a zero balance. (This should happen within 30 – 60 days after you pay them off.) If not, you can dispute them. Read:
      A Step-By-Step Guide to Disputing Credit Report Mistakes

      • David

        Hello Gerri, I had previously used the rehabilitation program for my student loans and then allowed them to go into default 2 years later. I’m currently in discussions with the collections agency about repayment options and was wondering what the best option would be for increasing my credit score. They have given me the option to pay whatever amount works for me monthly or loan consolidation. I have $44,000 in debt and it shows as 13 different accounts ony credit report. Will consecutive payments increase my credit score and should I consolidate? Thank you for your time.

        • http://www.Credit.com/ Gerri Detweiler

          It sounds like your student loan payments are generally unmanageable. I would not suggest you rely solely on the servicer or collection agency’s advice here. Instead, I’d recommend you talk with a non-profit credit counseling agency that provides this kind of help. You can
          find a student loan counselor here.

Credit.com receives compensation for the financial products and services advertised on this site if our users apply for and sign up for any of them.

Hello, Reader!

Thanks for checking out Credit.com. We hope you find the site and the journalism we produce useful. We wanted to take some time to tell you a bit about ourselves.

Our People

The Credit.com editorial team is staffed by a team of editors and reporters, each with many years of financial reporting experience. We’ve worked for places like the New York Times, American Banker, Frontline, TheStreet.com, Business Insider, ABC News, NBC News, CNBC and many others. We also employ a few freelancers and more than 50 contributors (these are typically subject matter experts from the worlds of finance, academia, politics, business and elsewhere).

Our Reporting

We take great pains to ensure that the articles, video and graphics you see on Credit.com are thoroughly reported and fact-checked. Each story is read by two separate editors, and we adhere to the highest editorial standards. We’re not perfect, however, and if you see something that you think is wrong, please email us at editorial team [at] credit [dot] com,

The Credit.com editorial team is committed to providing our readers and viewers with sound, well-reported and understandable information designed to inform and empower. We won’t tell you what to do. We will, however, do our best to explain the consequences of various actions, thereby arming you with the information you need to make decisions that are in your best interests. We also write about things relating to money and finance we think are interesting and want to share.

In addition to appearing on Credit.com, our articles are syndicated to dozens of other news sites. We have more than 100 partners, including MSN, ABC News, CBS News, Yahoo, Marketwatch, Scripps, Money Magazine and many others. This network operates similarly to the Associated Press or Reuters, except we focus almost exclusively on issues relating to personal finance. These are not advertorial or paid placements, rather we provide these articles to our partners in most cases for free. These relationships create more awareness of Credit.com in general and they result in more traffic to us as well.

Our Business Model

Credit.com’s journalism is largely supported by an e-commerce business model. Rather than rely on revenue from display ad impressions, Credit.com maintains a financial marketplace separate from its editorial pages. When someone navigates to those pages, and applies for a credit card, for example, Credit.com will get paid what is essentially a finder’s fee if that person ends up getting the card. That doesn’t mean, however, that our editorial decisions are informed by the products available in our marketplace. The editorial team chooses what to write about and how to write about it independently of the decisions and priorities of the business side of the company. In fact, we maintain a strict and important firewall between the editorial and business departments. Our mission as journalists is to serve the reader, not the advertiser. In that sense, we are no different from any other news organization that is supported by ad revenue.

Visitors to Credit.com are also able to register for a free Credit.com account, which gives them access to a tool called The Credit Report Card. This tool provides users with two free credit scores and a breakdown of the information in their Experian credit report, updated twice monthly. Again, this tool is entirely free, and we mention that frequently in our articles, because we think that it’s a good thing for users to have access to data like this. Separate from its educational value, there is also a business angle to the Credit Report Card. Registered users can be matched with products and services for which they are most likely to qualify. In other words, if you register and you find that your credit is less than stellar, Credit.com won’t recommend a high-end platinum credit card that requires an excellent credit score You’d likely get rejected, and that’s no good for you or Credit.com. You’d be no closer to getting a product you need, there’d be a wasted inquiry on your credit report, and Credit.com wouldn’t get paid. These are essentially what are commonly referred to as "targeted ads" in the world of the Internet. Despite all of this, however, even if you never apply for any product, the Credit Report Card will remain free, and none of this will impact how the editorial team reports on credit and credit scores.

Your Stories

Lastly, much of what we do is informed by our own experiences as well as the experiences of our readers. We want to tell your stories if you’re interested in sharing them. Please email us at story ideas [at] credit [dot] com with ideas or visit us on Facebook or Twitter.

Thanks for stopping by.

- The Credit.com Editorial Team