Getting Back on Track with Federal Student Loans

There are two types of student loans available to students and their parents; federal and private school loans.

Federal Student Loans

The U.S. government guarantees federal student loans made by the Department of Education. There are several benefits federal loans have over private loans for students. There are three types of federal loans borrowed by the student directly; federal Stafford subsidized and unsubsidized loans and Perkins loans. You can find out your total outstanding debt and who is currently servicing loans from the National Student Loan Data Systems of Students (NSLDS). This database shows information on federal loans only.

Subsidized student loans have the interest paid by the federal government while the student is in school.  Unsubsidized federal school loans will accrue interest right away are in school. Perkins loans are also subsidized and the interest rate is capped at 5%. However, these loans are only available to students with exceptional financial need.

Parents are able to take out Parent Loans for Undergraduate Students (PLUS) loans. Although these are federal loans, parents must pass a credit check to ensure eligibility for this loan. These loans are the responsibility of the parent.

Any federal loan offers several benefits over private school loans. Benefits include fixed interest rates, several repayment options, there are loan forgiveness programs for students that purse careers in public service, forbearance and deferment options, discharge if the student passes away or permanent disability. Federal student loan interest rates are set by the government. Students do not need credit checks or income verification to take out federal loans out.

Defaulting of Federal Student Loans

After 360 days of nonpayment federal loans are in default. If you default on student loans you are subject to having your wages garnished. The collection agency does not have to serve you and go through the courts to accomplish wage garnishment. Filing for bankruptcy will not eliminate federal debt. It does not matter if you file chapter 7 or chapter 13 – neither will eliminate the debt. Additionally, federal money such as social security payments and tax refunds are also subject to garnishment.

When your wages are garnished to repay your student loan debt, they are able to take 15% of your net salary — or 25% if you have two different creditors. The money is sent to the collection agency servicing the loan for payment. There are costs associated with student loan debt when the account goes to collection agency. These fees are paid in addition to the principal loan amount which increases the total amount you owe.

Curing Defaulted Student Loans (Federal)

In lieu of trying to get a bankruptcy discharge for federal student loan debt, you can rehabilitate or consolidate them.

Rehabilitation

To rehabilitate defaulted federal loan(s):

  • You must make nine (9) monthly payments within 20 days of the due date, and
  • Make the nine payment during 10 consecutive months

These loans must be serviced by the U.S. Department of Education. If the current collection agency is not eligible, you will need to take steps to have the loans moved to a qualified servicer.

The voluntary payments are based on 15% of your discretionary income. You will need to make these payments in addition to an wage garnishments already in place if the loans have gotten to this point. These payments will not count toward the 9 monthly payments.

Once you rehabilitate federal loans, any default status is removed from your loan and your credit report. Although, any late payments will still remain on your credit and can still affect your score. However, you can take out additional loans for education and qualify for both forbearance and deferment.

Consolidation

To consolidate a defaulted loan(s):

  • Repay the loan based on income-driven repayment plan. Income documentation must be provided
  • Make three consecutive payments, they must voluntary, on time and full monthly payments before consolidation

To consolidate Federal Perkins loans in default you must also consolidate a Direct Loan or FFEL Program loan. PLUS loans in default are eligible for consolidation only under the income-driven plan, Income-Contingent Repayment Plan (ICR).

Private Student Loans

The federal government does not fund private student loans. Instead they come from private lenders such as banks and credit unions. The student’s or parent’s credit worthiness determines the ability to borrow, the rate and the loan terms of private loans. Private student loans usually have variable interest that can increase the amount of the payments. There are fewer options to postpone and/or reduce payments. But, like federal loans there are usually options to postpone payment while you (or the student) is currently in school. With the increase in college tuition, students have to take out bigger loans. Students and parents turn to private loans because limits on federal student loans. Class level and the amount of current federal loans are the two of the most common factors.

Defaulting on Private Student Loans

Getting a bankruptcy discharge on private loans is very difficult but not impossible. However, if your parent or someone else co-signed the loan for you, negative payment history and/or filing for bankruptcy can have detrimental effects on the co-signers credit. To have the student loan discharged you must prove “undue hardship”. There are several tests that a court can use to test whether you are actually facing undue hardship. If you are attempting to discharge student loan in bankruptcy, get a lawyer. Student loan discharges are not part of the usual bankruptcy process.

Other Options for Student Loans (Private)

The reason you do not find much information on rehabilitating private student loans on the internet is because there is no one right way to complete this process. On the federal level there are specific guidelines the department of education servicers must follow. But, on the private level the lenders can make their own rules.

The private lender will generally follow a similar path, but you must understand they are under no obligation to work with you on the same level that a federal lender will work with you. For this reason, many borrowers will chose to only borrow federal money or at least keep this portion of the loan separate. Try to work with the lender to avoid having a collection agency get the loan. If a collection agency already has the loan, you are going to have to work the agency.

You cannot consolidate private loans and federal loans with a federal lender. However, there are some private lenders that will allow you to consolidate all loans. There private lenders will check your credit and decide if you qualify for consolidation based on your credit. If you are already in default on private loans your credit score is already hurt. Therefore, you will probably not qualify for consolidation under these private lenders.