For the past seven years, Kat has been helping people make the best financial decisions for their unique situations, whether they're looking for the right insurance policies or trying to pay down debt. Kat has expertise in insurance and student loans.
Kat Tretina Personal Finance WriterFor the past seven years, Kat has been helping people make the best financial decisions for their unique situations, whether they're looking for the right insurance policies or trying to pay down debt. Kat has expertise in insurance and student loans.
Written By Kat Tretina Personal Finance WriterFor the past seven years, Kat has been helping people make the best financial decisions for their unique situations, whether they're looking for the right insurance policies or trying to pay down debt. Kat has expertise in insurance and student loans.
Kat Tretina Personal Finance WriterFor the past seven years, Kat has been helping people make the best financial decisions for their unique situations, whether they're looking for the right insurance policies or trying to pay down debt. Kat has expertise in insurance and student loans.
Personal Finance WriterUpdated: Aug 14, 2020, 9:04am
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With so many college graduates leaving school with student loan debt, it’s no surprise that many end up falling behind on their payments. In some cases, graduates default on their federal loans, meaning they miss payments for 270 days or more.
Unfortunately, federal loan default is relatively common. According to the U.S. Department of Education, the national federal student loan cohort default rate—the percentage of federal loan borrowers who enter repayment in a specific year and default within three years—is 10.1% as of September 2019.
Federal loan default is a serious problem with steep consequences, including wage garnishment and damaged credit. Student loan debt isn’t usually cancellable or dischargeable in bankruptcy, so the effects can be long-lasting. However, you can get out of default through a process known as student loan rehabilitation, a benefit only available for federal loan borrowers, not private ones.
Note that the CARES Act provides relief to federal loan borrowers during the coronavirus pandemic. Until Sept. 30, federal loan payments are suspended, and interest rates are set at 0%. Collection efforts on defaulted loans are halted, and wages are no longer garnished. On Aug. 8, President Trump signed an executive order extending the CARES Act’s student loan benefits through the end of 2020.
Here’s how the student loan rehabilitation program works and how to decide if it’s right for you.
When you miss a federal student loan payment by as little as one day, your loan becomes past due, and your loan servicer considers you delinquent. If your account is delinquent for 90 days or more, the loan servicer will report the late payment to the three major credit bureaus—Equifax, Experian and TransUnion—and you risk entering default.
Direct loans and Federal Family Education Loan (FFEL) Program loans are considered to be in default if you don’t make your scheduled payments for 270 days or more. The consequences can be severe, including the following repercussions:
Because of how serious the effects of student loan default are, it’s important to get out of default as quickly as possible. The U.S. Department of Education created the student loan rehabilitation program as a structured path out of default.
According to the terms of student loan rehabilitation, you agree in writing to make nine “voluntary, reasonable and affordable” monthly payments within 20 days of the due date during a period of 10 consecutive months. If you meet those requirements, your loans will no longer be in default, and wage garnishment and other measures will end.
Loan rehabilitation is only available for federal direct and FFEL loans. To rehabilitate your debt, follow these steps.
To start the process, you must contact your loan servicer. If you’re not sure who your loan servicer is, you can contact the Federal Student Aid Information Center at (800) 433-3243, or you can use the online National Student Loan Data System to find your loan servicer.
When you call your loan servicer, tell the representative that you’re in default and are interested in student loan rehabilitation.
For the purposes of student loan rehabilitation, your loan servicer will set your monthly payment to an amount that is equal to 15% of your discretionary income—the difference between your adjusted gross income and 150% of the poverty guideline for your state and family size—divided by 12. Your loan servicer will require you to provide documentation of your income, such as a W-2 or pay stub.
Depending on your income and family size, you could qualify for a payment as low as $5.
You must agree to the payment amount in writing. You’ll pay this amount monthly, and you have to make nine payments within 10 consecutive months. That means you can miss just one payment and still stay on track for rehabilitation; if you miss more than that, you’re no longer eligible.
If you make all of the required payments within the 10-month period, your loans will no longer be in default. All collections activity will end, and wage garnishments and Treasury offsets will stop, too.
The record of the default will be removed from your credit report. However, the late payments that were previously reported before the loan was in default will still appear on your report.
Note: Under the CARES Act, you will get credit for suspended payments toward student loan rehabilitation if you’re already under a student loan rehabilitation agreement.
Your payment under the student loan rehabilitation program is 15% of your discretionary income divided by 12. Your discretionary income is the difference between your adjusted gross income and 150% of the poverty guideline for your state and family size.
For example, let’s say Jeff is married and lives in South Carolina. He has no children and has a household income of $45,000. In South Carolina, the poverty guideline for a family of two is $17,240; 150% of that guideline is $25,860.
Jeff subtracts the $25,860 from his household income—$45,000—to get his discretionary income. The resulting number is $19,140.
Under student loan rehabilitation, Jeff’s payment is 15% of his discretionary income divided by 12, so his monthly payment would be $239.25.
If the calculated payment is more than you can afford, you can ask your loan servicer to calculate your loan payment using an alternative method that considers your monthly expenses, such as medical bills and other extenuating circumstances.
You’ll need to fill out the Loan Rehabilitation: Income and Expense Information Form and provide documentation of your expenses and income.
There are some advantages to rehabilitating your student loans if they’re in default:
Once your loans are rehabilitated and you’re out of default, your loans are typically transferred to a new loan servicer.
You won’t have the same monthly payment that you had under the student loan rehabilitation agreement; instead, your servicer will place you under the standard repayment plan. Your new monthly payment won’t be based on your discretionary income, so it will likely be much more expensive.
If you can’t afford your monthly payment, remember that you’re now eligible for income-driven repayment plans. Applying for an income-driven repayment plan can make your monthly payment more affordable.
While student loan rehabilitation can be a useful strategy for getting out of default, it’s not for everyone. There are two other ways to manage your loans:
With this approach, you make three consecutive, voluntary monthly payments for the full required amount on your defaulted loan. Once you do so, you consolidate your debt with a direct consolidation loan and agree to repay the new loan under an income-driven repayment plan.
This strategy has some caveats:
While repaying your loans in full may sound impossible, it is another way to end your default status. Some people borrow money from friends or family to pay off their balance, though there are tax implications to this approach you should consider.
However, another way to pay off your loans and get out of default is to refinance your student loans. It’s difficult to do since student loan default can damage your credit, but if you have a co-signer with good credit to apply for a loan with you, you may qualify for a loan you can use to pay off your defaulted loans.
There are downsides to using student loan refinancing. When you refinance your loans, they become private loans, and you permanently lose out on federal benefits. You’ll no longer qualify for perks like income-driven repayment plans or federal forbearance, so think carefully about your options before going this route.
