In most respects, defaulting on a student loan has exactly the same consequences as failing to pay off a credit card. However, in one key respect, it can be much worse. Most student loans are guaranteed by the federal government, and the feds have powers about which debt collectors can only dream. It probably won’t be as bad as armed marshals at your door, but it could be very unpleasant.
Here’s what happens.
- You may be able to use federal student loan assistance programs to help you repay your debt before it goes into default.
- Let your lender know if you may have problems repaying your student loan.
- Failing to pay your student loan within 90 days classifies the debt as delinquent, which means your credit rating will take a hit.
- After 270 days, the student loan is in default and may then be transferred to a collection agency to recover.
First, You’re ‘Delinquent’
When your loan payment is 90 days overdue, it is officially “delinquent.” That fact is reported to all three major credit bureaus. Your credit rating will take a hit.
That means any new applications for credit may be denied or given only at the higher interest rates available to risky borrowers. A bad credit rating can follow you in other ways. Potential employers often check the credit ratings of applicants and can use it as a measure of your character. So do cell phone service providers, who may deny you the service contract you want. Utility companies may demand a security deposit from customers they don’t consider creditworthy. A prospective landlord might reject your application.
Defaulting on a student loan has most of the same consequences as failing to pay off a credit card.
The Account is ‘In Default’
When your payment is 270 days late, it is officially “in default.” The financial institution to which you owe the money refers your account to a collection agency. The agency will do its best to make you pay, short of actions that are prohibited by the Fair Debt Collection Practices Act. Debt collectors also may tack on fees to cover the cost of collecting the money.
It may be years down the road before the federal government gets involved, but when it does, its powers are considerable. It can seize your tax refund and apply it to your outstanding debt. It can garnish your paycheck, meaning it will contact your employer and arrange for a portion of your salary to be sent directly to the government.
What You Can Do
These dire consequences can be avoided, but you need to act before your loan is in default. Several federal programs are designed to help, and they are open to all who have federal student loans, such as Stafford or Grad Plus loans, although not to parents who borrowed for their children.
Three similar programs, called Income-Based Repayment (IBR), Pay As You Earn (PAYE), and Revised Pay As You Earn (REPAYE), reduce loan payments to an affordable level based on the applicant’s income and family size. The government may even contribute part of the interest on the loan and will forgive any remaining debt after you make your payments over a period of years.
The balance is indeed forgiven, but only after 20 to 25 years of payments. The payments may be reduced to zero, but only while the indebted person has a very low income.
The Public Service Loan Forgiveness Program is designed specifically for people who work in public service jobs, either for the government or a nonprofit organization. People who participate may be eligible for federal debt forgiveness after 10 years on the job and 10 years of payments.
Details of these federal programs are available online, as is information about eligibility. It is important to remember that none of these programs are available to people whose student loans have gone into default.
A good first step is to contact your lender as soon as you realize you may have trouble keeping up with your payments. The lender may be able to work with you on a more doable repayment plan or steer you toward one of the federal programs.
There is an upside to student debt. If you keep up your payments, it will improve your credit score. According to Experian, consumers with student loan debt on average have a higher credit score than those who are student-debt free. That solid credit history can be crucial for a young adult trying to secure that first car loan or home mortgage.
A true worst-case scenario was a man who found himself with armed U.S. marshals on his doorstep. He borrowed the money 29 years earlier and failed to repay the loan. The government finally sued. According to the U.S. Marshals Service, several attempts to serve him with a court order failed. Contacted by phone in 2012, he refused to appear in court. A judge issued an arrest warrant for him that year, citing his refusal to appear. When the marshals finally confronted him outside his home, he told CNN, “[I] went inside to get my gun because I didn’t know who these guys were.”
That’s how you end up facing an armed posse of U.S. marshals, with local police as backup, for failure to pay a student loan of $1,500. For the record, the man said he thought he paid the debt, didn’t know about the arrest warrant, and didn't remember the phone call.
However, even this sorry story has a reasonably happy ending. Hauled into court, at last, the man agreed to begin paying off his ancient student loan, plus accrued interest, at the rate of $200 a month. After 29 years of interest, the $1,500 debt had grown to around $5,700.
The Bottom Line
The government and banks have an excellent reason for working with people who are having trouble paying off their student loans. Student loan debt has reached an all-time high, with an estimated 45 million people now owing an average balance of $37,000. You may be sure the banks and the government are as anxious to receive the money as you are about repaying it.
Just make sure you alert them as soon as you see potential trouble ahead. Ignoring the problem will only make it worse. (For related reading, see "Who Actually Owns Student Loan Debt?")