Should I Rehabilitate or Consolidate My Defaulted Federal Loans?

student loan rehabilitation

If your student loans are in default, the stress of dealing with collections agents, possible wage garnishment, and tax offsets can be enough to make you want to bury your head in the sand. But your situation can only get worse if you are not proactive and explore the options available to you.

Federal student loan borrowers have two paths to escape default: student loan rehabilitation or consolidating the defaulted student loans. Each option has its pros and cons, but either choice will set you on the right track to getting out of default and improving your financial situation.

Here’s what you need to know about dealing with default through either student loan rehabilitation or consolidation.

Understanding default

It’s important for all borrowers to know what default is and how it can affect them.

A student loan borrower is considered to be delinquent the day after she misses a scheduled loan payment. As long as the borrower makes the payment as soon as she can or contacts her loan servicer to discuss her options, a delinquency will not necessarily hurt her standing or finances.

However, the account will remain delinquent until the loan is made current; that is, until the borrower makes the payments necessary to bring her loan up to date. The delinquency becomes really problematic 90 days after the initial missed payment, at which point it is reported to the credit bureaus.

After 270 days with no payments the loan goes into default, which means the loan is assigned to a collection agency, the borrower loses eligibility for forbearance or deferment, and she faces the possibility of wage garnishment and a tax offset.

On top of that, student loans in default are reported to the credit bureaus, and it could take years to re-establish a credit rating.

Student loan rehabilitation

Borrowers who are already facing default may choose to rehabilitate their student loans to rectify the situation.

Rehabilitation is a process that allows you to remove your default status. If you have more than one student loan, you must apply to rehabilitate each one separately, and you may only rehabilitate a loan one time.

In order to rehabilitate, you must make nine payments within a ten-month period to have your default status removed. Your payments under rehabilitation are expected to be reasonable based upon your financial situation.

The loan servicer will request payments equal to 15 percent of your discretionary income. If you cannot afford those payments, you may ask your lender to recalculate the payment amount based on your documented income and expenses. It’s possible for borrowers in extreme financial distress to have rehabilitation payments as low as $5.

Once you’ve made your nine payments, your loan is considered rehabilitated and the default is removed from your credit history — although the late payments will remain on your credit history. During the period of rehabilitation, you may still be contacted by collection agents since they may continue to pursue borrowers during the process of rehabilitation.

Rehabilitating your loan could result in fees of up to 16 percent of unpaid principal balance and accrued interest to the principal balance of the loan. However, rehabilitation will restore your eligibility for benefits like deferment, forbearance, loan forgiveness, and a choice of repayment plans.

That means you can make the necessary changes to your monthly payments to keep them affordable post-rehabilitation.

Consolidate defaulted student loans

The other option for a borrower with student loans in default is to consolidate his debt. With Federal Direct Loan consolidation, your defaulted loan will be paid off, leaving you with a single, larger loan with one monthly payment and a fixed interest rate.

Even if the government is already garnishing your wages, you can still roll your loans into a new Direct Consolidation loan. Once you take out the loan, your old loans will be paid off and your wages will no longer be garnished.

There are two ways to qualify for a consolidation on a defaulted student loan:

  • Agree to repay your new loan under an income-driven repayment plan.
  • Make three consecutive monthly payments on your defaulted loan before you apply for consolidation.

If you choose to consolidate defaulted student loans under an income-driven repayment plan, you must choose one of the available income-driven repayment plans and provide proof of your income.

If you make the three on-time payments to qualify for consolidation, then you may choose any repayment plan you are eligible for as soon as the consolidation process is complete. Generally, consolidating defaulted student loans takes about 30 days.

Once you have consolidated your defaulted student loan, collections agents may no longer contact you. However, your credit report will still include the information about your default for up to seven years, meaning rehabilitation is the better option for borrowers who are worried about their credit history.

A borrower who is consolidating defaulted student loans will face fees up to 18.5 percent of the unpaid principal balance and accrued interest. But like rehabilitated loans, consolidated loans are once again eligible for benefits like deferment, forbearance, and loan forgiveness once the process is complete.

As with student loan rehabilitation, consolidation of a defaulted loan is a one-time opportunity. It will not be available to you again should you face another default.

How to get student loans out of default

It can be easy to panic when collections agents are calling about your defaulted student loan, but there are options available to help you end the default and get back on track to repayment. Either student loan rehabilitation or consolidation can help you put your default behind you.

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