When you take out a student loan, you have the best of intentions to repay it in full and on time. But, sometimes things just don’t go according to our plans. If you’re going through a temporary rough patch, you might have a hard time repaying your loan.
This puts you at risk of defaulting your student loans. It can also influence your credit history and inflict other consequences. Debt statistics are also burgeoning, which could mean that lenders and loan servicers will impose more intensive qualification and approval process.
For these reasons, it’s important that you handle the situation thoroughly to protect yourself and your access to capital in the future.
What is a Student Loan Default?
Loan default happens when a borrower fails to repay a debt as stated in the initial repayment terms. In the case of student loans, it means missing successive payments for weeks or months.
Fortunately, loan servicers and lenders grant a grace period before they penalize the borrower due to a missed first payment. The time between defaulting the loan and missing a loan payment is called delinquency. This period will give the debtor time to avoid default by making up missed payments or contacting their loan servicer.
In case you failed to take actions within this period, here’s what can happen next.
It Will Harm Your Credit Score
A bad mark on your credit report is one of the immediate, major consequences of defaulting your student loan. The late or missed payments that caused the default, as well the default itself, will be reported to the major credit bureaus. It will also come with a notation that the loan may be transferred or in collections to a different entity. All of which, can tank your credit score in one strike.
The negative reporting will continue while the student loan will remain in its default status. It will leave a long trail of damages in your credit history. Know it that a negative credit report can make it difficult for you to get approved for a mortgage or rent an apartment.
Acquiring an auto loan or type of line of credit could also be a big problem. The same goes with looking for a job. There are employers, particularly in the financial sector, who conduct background checks and request a copy of your credit report which could jeopardize your employment prospects.
It Will Inflict Financial Penalties
A financial penalty is another major consequence of defaulting student loans. It’s also called “collections charges” that can be evaluated on the underlying loan balance because of default.
For federal student loans, federal law permits vast collections of penalties and charges to be evaluated on defaulted loan balances. Also, federal courts have upheld collections and penalties charges of up to 25% of the combined interest and principal balance for defaulted federal student loans.
It’s a little more variable for private student loans. You might encounter collections charges evaluated on private loans too if the private student loan contract will allow collection and penalty charges. Those charges must be deemed reasonable by state law. However, it’s not always the case.
You’ll Lose eligibility for Deferment or Forbearance
A lot of student loan programs offer deferment, forbearance, and income-based repayment plans to help students who struggle with their monthly payments. These programs can help students deal with stretches of underemployment or unemployment, and get caught up on other financial obligations.
But, once your student loan defaults, your entire balance will become due, and you will lose access to these options.
Your Loan May be Sold to a Third-party Collection Agency
You original loan provider might not be aggressive enough in trying to get you to pay, perhaps they made a few calls, or sent a few letters. But, third-party collection agencies that purchase delinquent debt can be much more persistent in mailing and calling you about your debt.
An unpaid account may be sold off to one of these agencies that will aggressively chase you for settlement or payment on the balance.
The possibility of a lawsuit is one of the most severe consequences of defaulting student loans.
Lenders of Federal student loan, including the U.S. Department of Education, seldom sue the borrowers of defaulted student loans. It owes to the fact that the government has a lot of powerful collection tools at their disposal that doesn’t need a court appearance.
But, it’s quite a different case for private student loan lenders who sue borrowers in state court to obtain a judgment. It’s the only way for them to go after a borrower’s income or property. What a private student loan lender can do will heavily depend on state law.
It Will Garnish Your Wages
Collection agencies, under certain circumstances, can take legal action against you for defaulting on your student loans. It could mean that your wages will be garnished by your employer, your federal or state tax returns will be withheld and that many other consequences can follow.
It Will Cause Social Security Offset
Unbeknownst to many, the Treasury Offset Program doesn’t only dwell with federal tax refunds. In some cases, this program also authorizes the federal government to seize a fraction of your Social Security payments. And, it can be disadvantageous for older borrowers with fixed income.
The same with an administrative wage garnishment, borrowers can contest any Social Security offset before it begins. Private student loan lenders under most state laws, can’t pursue a person’s Social Security benefits via the state courts.
It Will Lead to Tax Refund Seizures
Intercepting your federal tax refunds is one of the federal government’s most powerful tools to pursue the borrowers of federal student loans. It’s executed through the Treasury Offset Program that allows the IRS (Internal Revenue Service) to grasp your federal tax refund and impose it to your federal student loan debt.
This program can be disastrous to borrowers with low income who may need their tax refund to cover living expenses. It can also be a problem for married couples with joint taxes. The entire joint tax refund of the couple can be seized, although there are cases wherein the spouse who suffered due to the seizure may have an option to file for “injured spouse’s claim.”
Fortunately, private student loan lenders can’t seize your federal tax refunds.
How you resolve or prevent a default depends on the type of loan, the lender, and your particular circumstances. However, communication is often key. You need to face the issues head-on and look for solutions that work for both parties.
The bottom line is that no matter how bad a default is, it’s still fixable. If you find yourself on the verge of defaulting student loans, now could be the right time to talk to a professional and find out what your legal options and rights may be.
Tiffany Wagner is currently taking a degree in Investment Management Analysis in her junior year in college. In the context of decision making and business strategy, she focuses on finance and information interpretation.