Avoiding Default

Never default on your loans. Bankruptcy and loan default are sometimes portrayed as the easy way out of apparently insurmountable debt, but these actions have severe negative consequences that will affect your long-term financial health. Defaulting on loans incurs fees and severe penalties. Defaulted loans remain on your credit record for up to 7 years after the claim is paid and will damage your credit rating, preventing you from getting credit cards, auto loans and mortgages, and may make it very difficult for you to get a job or rent an apartment or house.

Declaring bankruptcy is not a way to escape student loan repayment. According to FinAid.org, less than 1% of bankrupt borrowers succeed in getting their student loans discharged during bankruptcy proceedings.

If you default on a federal loan, lenders can:

  • Garnish (withhold) up to 15% of your wages and Social Security benefits;
  • Intercept your federal and state income tax refunds;
  • Intercept your state lottery winnings;
  • Charge you up to a 6% late fee on each late payment;
  • Assess collection charges of up to 25% from each payment on your defaulted loan (prolonging the repayment program and increasing your long-term costs);
  • Assess court and attorney's fees associated with the collection of the debt;
  • Block the renewal of your professional license;
  • Prohibit you from enlisting in the Armed Forces;
  • Make you ineligible for more federal student aid; and
  • Hire a collection agency to pursue repayment

Don't wait until you're on the verge of bankruptcy before you evaluate your options for avoiding loan default. Contact your lender and discuss your situation with them. Options are more limited for private student loans.

Tips for preventing default:

  1. Borrow the smallest amount possible
  2. Make sure you fully understand the terms of the loan and your options before signing
  3. Keep track of all of your loans
  4. Make your payments on time
  5. Notify your lender of any changes that could affect the repayment of your loan (including name or address change, graduation, leave of absence, transfer, etc.)
  6. Consider a deferment or forbearance for short-term hardship
  7. If you apply for a deferment or forbearance, continue making payments in full and on time until your lender notifies you that the deferment/forbearance is approved and in effect
  8. Talk to your lender about alternate repayment options such as extended repayment, graduated repayment, income sensitive repayment, income contingent repayment and income-based repayment.
  9. Consider consolidating your loan(s)
  10. Keep thorough records
  11. If you have a private loan as well as a federal loan but can only afford to make payments on one loan, place your priority on the federal loan to avoid default. Federal loans offer more flexible repayment options and assess harsher penalties for default.

Federal loans offer more options for dealing with financial responsibility. Options include the following:

  • Temporary suspension of loan payments for short-term financial difficulty, such as maternity or medical leave, or short-term unemployment
  • Economic hardship deferment (3-year limit); note that interest will continue to accrue during this period on unsubsidized loans
  • Forbearance (5-year limit); note that interest will continue to accrue during this period
  • Changing repayment plan to a longer repayment period or different repayment option, such as income-based repayment or extended repayment. Remember, however, that although this reduces the monthly payment, you will end up paying more over the long term. You can change the repayment plan once per year, so you can - and should - change back to the shortest possible repayment schedule when feasible.

While forbearance may seem like a reasonable option when facing financial challenges, the interest that accrues during that period will be capitalized (added to the balance of the loan) and the net result is an increase in the life-of-loan cost. For example, using a $10,000 Stafford Loan at 6.8% interest and a 10-year repayment term, a 3-year forbearance almost doubles the total cost of the loan; a 6-year forbearance almost triples the total cost; a 9-year forbearance quadruples the cost; and a 12-year forbearance increases the life-of-loan total by 5.5.

Obviously, deferments and forbearances can provide short-term relief (with long-term implications that can be negative) but are not suitable for long-term financial difficulty. For long-term financial hardship, you should explore the options of extended repayment, income-contingent repayment or income-based repayment.

Additional resources:

FinAid.org
Quick Reference Guide: Repaying Student Loans
Solutions for Borrowers Who are Having Trouble Repaying Education Loans
Economic Hardship Deferment Calculator
Defaulting on Student Loans
Loan Repayment Protection
Student Loan Debt Settlements

Federal Student Aid
Addressing Your Defaulted Student Loan

Fastweb.com
The Horrors of Defaulting on Education Debt

Student Loan Borrower Assistance

Safeborrowing.com
Student Loans: Financing Your Education