Student Loans in Default? Here’s How Rehabilitation Can Help You Recover

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Defaulting on your student loans is a serious financial issue you should avoid if at all possible. But if you’re already there, you may be looking for a way out.

Have you considered rehab? 

Loan rehabilitation is one option for getting your federal student loan out of default. 

It’s not an easy or quick process — and we’ll offer some alternatives — but it can help you recover from the financial crisis a default can cause.

Here’s how student loan rehabilitation can help.

What Is Student Loan Rehabilitation?

First, you need to know if your federal student loans are in default, which is easy enough to figure out. Start by determining how much you owe in student loans — and to whom you owe it. 

If you’ve missed payments on your Federal Family Education Loan (FFEL) or direct student loan for 270 days (about nine months), your loan is considered to be in default.

Unfortunately, if that’s the case, you have company.

More than 350,000 borrowers had loans that entered default in the third quarter of 2019 — a 42% increase compared to the same period in 2018, according to the National Student Loan Data System. 

Pro Tip

Your loan becomes delinquent the first day after you miss a payment. Before that happens, ask your loan servicer about deferment, forbearance or alternative repayment plan options.

Defaulting on your loans can have serious repercussions. Having that mark on your credit report will tank your credit score and make you ineligible for additional federal student aid — also, the government could start to collect the debt by garnishing your wages or income tax return refunds.

Student loan rehabilitation is a nine- to 10-month process for putting your loan back into good standing and removing the mark from your credit report.

But rehabilitation requires a strict payment schedule and you don’t get a second chance, noted Alexandra Wilson, a Certified Financial Planner and student loan expert at SmartPath. So you should be prepared to commit to rectifying your financial situation. 

“Loan rehabilitation is only offered once, so if (borrowers) begin the process, they should be sure to have a plan to afford the payments going forward,” wrote Wilson, who responded via email.

Wondering if rehabilitation is right for you — and how to do it? Here’s what you need to know.

Why You Should Consider Student Loan Rehabilitation

If your loans are already in default, you are probably familiar with the consequences. Loan rehabilitation can offer the following changes to your current situation:

  • You can make lower payments while you’re in the program — you must make all nine payments during a period of 10 consecutive months.
  • After completing the rehabilitation program, your loan holder will stop garnishing your wages.
  • After completing a rehabilitation program, the default is removed from your credit history. 
  • After completing the program, you’ll regain eligibility for deferment, forbearance and forgiveness, along with a choice of repayment plans.
  • After completing the program, you’ll be eligible to receive federal student aid again.

“Compared to doing nothing, rehabilitation will save a ton on interest and collection fees,” Wilson wrote.

How Do You Start Loan Rehabilitation? 

If you’re ready to rehabilitate your loan, you’ll need to call your loan servicer or the collection agency handling your loan.

Wilson recommended speaking with a student loan attorney if you need additional guidance during this process.

Borrowers should “keep a detailed record of everyone they’ve spoken with and a file with all correspondence and statements,” she wrote.

How Much Do You Pay During Loan Rehabilitation?

Payments for a rehabilitation plan are set by the loan servicer to be reasonable and affordable to you. 

To figure out how much you’ll be paying during loan rehabilitation, start with your adjusted gross income. Subtract 150% of the poverty line based on your household size. Lenders will typically make the payment 10% to 15% of that amount.

Your adjusted gross income is your income after allowed tax deductions — it’s typically lower than your gross income.

For example, if you’re single with no dependents, the poverty line in every state except Alaska and Hawaii is $12,490. So if your adjusted gross income is $30,000, here’s how you’d calculate your payment at a rate of 15%:

$30,000 – ($12,490 x 150%) = $11,265 x 15% = $1,689.75 /12 = $140.81 monthly payment

“If that payment is too high for the borrower, they can ask their lender for a payment that considers their income and expenses,” Wilson wrote. “It’s possible to get a payment as low as $5.” 

After making the nine required payments within 10 months, you’ve completed the rehabilitation process and your loan comes out of default. You can then apply for an Income-Driven Repayment plan. 

What If You Can’t Make the Payments?

As we mentioned earlier, you shouldn’t put your loans in rehab unless you’re ready to commit. The federal government only allows student loan rehabilitation once, and if you’re unable to make the payments during the process, your loans will go back into default, and you should expect the government to garnish your wages and tax refunds until the loan is paid off.

For borrowers, “getting their loans out of default is important, and could be their only shot if they’ve already started,” Wilson wrote. “If they have started the process and are not able to make a payment I suggest trying to find other options to either make more money or cut expenses.” 

What Are the Alternatives to Rehabilitation?

Rehab isn’t a quick fix for your student loans. For one, 10 months is a long time to make those payments, especially if you aren’t used to making any payments. 

And although the default will be removed from your credit history, the hit to your credit score will take some time to recover.

“It could take up to almost a year before it ever gets posted to your credit report,” said Jamie Dickenson, Certified Educational Planner, who added that any late payments before the loan went into default will still show up on your credit report for another seven years.

There are two other options: paying off the loan in full or consolidating.

Pro Tip

If your wages are already being garnished, you can’t consolidate your student loans. Speak with your student loan servicer as soon as possible to start the rehabilitation process. 

The first option may not be an option at all, unless you have been hoarding your savings or have a relative or friend willing to loan you the money. But if you can pay off the loan in full, that’s your best choice, according to Wilson.

Consolidation vs. Rehabilitation

The second option, consolidation, is a quicker process than rehabilitation. It typically takes 30 days to consolidate the loans, at which point borrowers can apply for an Income-Driven Repayment plan. Then after three consecutive monthly payments, your loan is no longer in default. 

However, consolidation comes with its own limitations.

If you already have a Direct Consolidation Loan, you can’t consolidate it again unless you have at least one additional loan. And unlike rehabilitation, consolidation won’t remove the record of the default from your credit history. 

Also, consolidation could end up costing you more in the end.

“The fees for consolidating defaulted student loans (18%) are typically higher than doing a loan rehabilitation (16%),” Wilson wrote. 

Whichever option you choose, it’s worth your financial future to get your student loans out of default.

Tiffany Wendeln Connors is a staff writer/editor at The Penny Hoarder. Read her bio and other work here, then catch her on Twitter @TiffanyWendeln.