Downside of Student Loan Default

24 Apr

Brandon Endsley, Financial Aid Administrator and Purdue Alumni
www.purdue.edu/mymoney

student loan debt loan

thinking about debt

Before I discuss the downsides of student loan default, you probably need to know what the term student loan default means.  A student loan default occurs when a student accepts a loan to cover their higher education costs and fails to fulfill the payment obligations they agreed upon once the loan has entered repayment. If your loans enter default status do not feel embarrassed.  Many other student loan borrowers can relate to your situation.  According to the Federal Reserve Bank of New York in 2011, 27% of the 37 million student loan borrowers could not meet the repayment obligations and have defaulted on their student loans.  That means approximately 10 million Americans could not make their student loan payments.

Problems for the 10 million Americans in student loan default go above and beyond the ability to make payments.  There are 6 common consequences that can occur from a student loan being placed in default status.

1.)   A loan default in any category (mortgage, car, or credit card), would result in a negative effect on your credit score.

When entering into student loan default, all three credit reporting agencies are notified, causing your credit score to drop up to 150 points.    The maximum credit score is 850.  What is considered poor credit starts below 700 points.  If your credit score started at 850 points, a credit reduction of 150 points will have a negative effect on your ability to receive additional loans in the future.  A poor credit score can result in a denial of a future mortgage, car loan, or even the opportunity to obtain a credit card.  A loan default can also affect your ability to attend higher education institutions.

 2.) While your student loans are in default status, you cannot receive additional financial aid.

If you want to return to college and receive your associates, bachelors, masters, or even Ph.D., and your loans are in default, you will have to fund the complete cost of your education without federal aid.  This means, you will also not be eligible for federal, state, or institutional grants, scholarships, or loans, regardless of where you previously attended.

3.) The federal government can garnish your wages.

One avenue the government can use to receive payment on your defaulted loans is through wage garnishment.  Wage garnishment is where the federal government takes a percentage of your paycheck until the student loan debt has been paid off.  The federal government may take up to 15% of your wages, but the amount they take cannot exceed 30 times the federal minimum wage.

4.)  You will not receive a refund from your tax return until you are out of student loan default.

Along the same avenue, the federal government can also withhold tax refunds from the federal or state tax returns, and apply the funds to the overall student loan debt.  In addition to the garnishments listed above, the government can garnish federal benefits you receive to pay towards your debt.  An example of this would be, garnishing your Social Security Disability benefits (SSD).

5.)  You can be sued for debt owed.

Another way the government can receive funds owed is through the court system.  The federal government can sue for defaulted student loan debt.  Also, provisions for a statute of limitations do not exist. This means the federal government does not have a time frame limitation to sue and can bring a case against you to at any time.

The last two consequences include bankruptcy and additional fees.

6.) You cannot discharge your student loans in bankruptcy and you will be charged additional fees.

Bankruptcy is a reallocation of your assets to resolve your debt issues.  In previous years, student borrowers could include student loan debt in bankruptcy.  Now that policies have changed, student loan debt can only be included if approved by the court. 

Additional fees, charges, and collection cost involved in the defaulted student loan process mark the last consequences to consider.  Each debt retrieval avenue listed above costs either the federal government or collection agencies money.  The costs are then passed down to you, as the owner of the loan.  These fees will only increase the amount owed on the loan, and increase the repayment period.

Life happens, and situations can arise that make the repayment of a student loan difficult or even impossible.  Loss of a job, the inability to find employment after graduation, or just not earning enough money can all be reasons a loan may go into default.  The government understands these situations and has alternative repayment options for borrowers who fall into hard times.  Before your loans go into student loan default, be proactive. Call your lender and find out about the different options that may be available to you.  There are other options to help you through these tough times before causing further financial headaches.

One Response to “Downside of Student Loan Default”

  1. MyMoneyPurdue June 15, 2012 at 8:52 PM #

    I could not agree more. Being Proactive in all aspects of your personal finance can save you time and future headaches.

    Like

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