How to Rehabilitate Student Loans

    Over 4 million Americans have defaulted on their student loans. Here are some ways to take control of your student loans.Tens of millions of Americans struggle with a mountain of student loan debt and each year huge numbers simply stop making payments and end up in default.

    That is a decision that undermines their creditworthiness and puts their financial well-being in jeopardy.

    About 44 million people carry more than $1.4 trillion in federal student loan debt in 2017, and 4.2 million of them were in default. During 2016, 1.1 million borrowers stopped making payments. That’s more than 3,000 defaults a day. According to a Consumer Federation of America analysis of federal student debt data, defaults increased 14% from 2015 to 2016.

    It’s important to remember that when you default on a student loan, you are no longer eligible for loan modification, deferment, forbearance, repayment plans, forgiveness or consolidation until you rehabilitate your loan. And there are broader consequences, for instance you might be denied a car loan or a credit card, and if you succeed in getting a loan, the interest rate could be extremely high.

    Given the scale of the problem, student loan debt has emerged one of the nation’s top personal finance concerns. Defaulting on a loan can add years to a repayment schedule and result in collection fees that are added to the loan balance.

    Fortunately, options are available. They include forbearance and deferment, which allow borrowers to temporarily stop or reduce payments. Federal student loans allow borrowers to defer payments for a long as three years if they have financial hardships or are enrolled in post-secondary school.

    Student loan rehabilitation programs are another alternative. These are agreements between borrowers and lenders that can erase defaults from the borrowers’ records as long as they stick to a strict repayment plan, typically for 10 consecutive months. Rehabilitating loans clears a black mark from borrowers’ financial histories, repairing credit scores and restoring their ability to borrow in the future.

    Failing to enter student loan default rehabilitation can severely damage a borrower’s creditworthiness and can lead to court-ordered wage garnishments.  If your wages are already being garnished, the student loan rehabilitation process can stop the income seizures and return control to you, but you must take the first step by contacting your collection agency and requesting rehabilitation.

    If your loan enters a rehabilitation plan, your credit history will be repaired. Your eligibility for loan deferment, forbearance and forgiveness will also be restored. Direct, FFEL, Perkins, Stafford, PLUS, Grad PLUS, Consolidation, SLS, HPSL and NSL – are eligible for rehabilitation.

    The traditional rehabilitation process is based on a 10-month plan; but can last as little as 4 months or as long as 12 months, depending on the lender. Rehabilitation of a federal Perkins Loan is accomplished in nine consecutive months with payments determined by the loan holder. Other programs, such as the William D. Ford Federal Direct Loan Program and the Federal Family Education Loan Program, operate similarly, but require nine payments to be made in 10 months.

    Advantages to seeking loan rehabilitation:
    • It puts your loan back in good standing.
    • It makes you eligible for deferment, forbearance, consolidation, forgiveness and alternative repayment plans.
    • You are eligible for additional loans and financial aid.
    • You are no longer subject to collections activity or legal issues over your loan.
    • It can stop wage garnishments.
    • Your credit report will reflect positive progress in loan repayment. Negative marks on your credit from the defaulted loans will be removed.

    Student loan debt in 2017 is nearly double the $800 billion owed on credit cards. College graduates in the class of 2016 had an average student debt load of $37,162, a 6% increase from 2015. As the burden grow worse, student debt is an emerging political issue, but so far debt relief remains elusive and college costs continue to climb.

    Though government might eventually try to lessen the burden, students should clearheadedly consider the difficulties they face repaying their loans. It is prudent to estimate the amount of income needed to repay loans and determine whether your salary can handle that amount.

    For most borrowers, the first line of defense is avoiding default. To remain in good standing with your lender, fully understand your loan agreement, only borrow money you absolutely need and budget your expenses. When you have graduated, track your loans on line, keep good records of all transactions related to the loan and the contact information for the lender. It is best to notify your lender right away if you face problems making a payment.

    If you’ve defaulted on your student loan payments, you might consider both loan rehabilitation and loan consolidation. If you have more than one student loan, you can try to consolidate your loans into a direct consolidation loan. You must agree to repay the new loan and make three consecutive on-time payments on the defaulted loan or loans you plan to consolidate. Unlike a loan rehabilitation program, a loan consolidation doesn’t remove the record of default from your credit history. 

    Step One: Start the Rehabilitation Process

    Student loans go into default when no payments have been made for nine consecutive months. Once the loan has reached the default stage, you must start the rehabilitation process before more damage is done.

    The monthly payment plan you enter must be reasonable and affordable for you. The loan holder will use a system called income-based repayment to compute the installments you’ll pay unless you object. The lender will discuss the advantages and disadvantages of loan rehabilitation and loan consolidation with you. If you decide on rehabilitation, the lender or debt collector will review repayment plans.

    The most common plan used for rehabilitation loans, and the one required for consolidation loans, is income-based repayment. As the name suggests, repayment installments are computed using your income, and are adjusted over time as your income changes. Payments are capped at 15% of annual discretionary income. You can negotiate a lower rate if the lender or collector is willing to offer one.

    Income-based repayment has advantages over fixed-rate repayment plans. No matter how much your income increases, you won’t be obligated to pay more each month than the amount you would have paid under a 10-year standard repayment plan. In addition, you are eligible for loan forgiveness after 20 or 25 years, depending on when you borrowed the money.

    If the lender turned your account over to a collection agency, you can try to negotiate with the agency. Collection agencies can add costs to a loan in default. A federal law enacted in 2014 limits collection costs to no more than 16% of the unpaid balance and accrued interest on the loan. The federal Department of Education doesn’t charge collection fees on federal Direct Loans, but that could change in the future.

    One caveat: Loan rehabilitation is usually a one-time opportunity. If you fail to meet the terms, or you loan goes into default again in the future, you aren’t allowed to try again. There is an exception, however, for those who entered rehabilitation before August 14, 2008. Anyone who rehabilitated a loan before then if allowed a second rehabilitation.

    Step Two: Make Timely Payments

    Loan rehabilitation is successful only if you stick to the negotiated plan. In other words, you cannot miss a single payment. If you have a Perkins Loan, you must make nine payments in nine months to rehab those loans.

    Payments are on-time when the loan or collection agency receives payment within 20 days of the due date. Perkins Loans payments are due 15 days from the due date. The monthly payment must equal the rate in the agreement. If it is a penny less, it can be considered a missed payment.

    Qualified military service members or civilians affected by family members in the military are allowed to miss a rehabilitation payment. People in this group must resume their payments when their service obligations are completed.

    Step Three: Trust, But Verify

    Your loan is considered rehabilitated when you complete the agreed-upon monthly payment plan. At that time, the default will be removed from your credit history.

    Loan rehabilitation is a valuable way out, but you must be prepared.

    Remember that rehabilitation this is a one-time option. There is no recourse if you default a second time. After your loans are rehabilitated, you will then be eligible for Student Loan Consolidation.

    Bill Fay

    Bill Fay is a journalism veteran with a nearly four-decade career in reporting and writing for daily newspapers, magazines and public officials. His focus at Debt.org is on frugal living, veterans' finances, retirement and tax advice. Bill can be reached at bfay@debt.org.

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