In life, there are few do-overs. Most of the time when you mess something up, it is what it is and you have to move on. But sometimes – and these times are wonderful – there is a way to sort of erase the bad that happened because of a mistake you knowingly or unknowingly made.
The one-time chance to rehabilitate a student loan is one such time. It’s sort of the federal government’s rare get-out-of-jail free card extended to people who previously defaulted on a federal student loan.
Let’s see why this is such a big deal.
Before we start, it’s important to note the difference between a defaulted and a delinquent federal student loan. Federal student loans are in default if you are 30-60 days late on a payment. They are considered in default if you are 270-360 days behind on payment.
The Effect of Defaulting on a Federal Student Loan
All student loans end up on your credit report, including the ones you are paying consistently on (this is good, as it helps to build your credit score). However, delinquent loans will be given what’s called a ‘derogatory mark’ (any negative mark on your credit report).
By law, the federal government can continue reporting a federal student loan as delinquent indefinitely (or until it’s paid back). This is significant, as other types of debts and derogatory marks can disappear from your credit report after so many years. And of course at some point (between 270-360 days) the loan goes into default if no payments have been sent.
Note: It’s important to know that the Department of Education can also continue collecting on federal student loans until they are paid (or indefinitely). They have various tools to help them, including wage garnishment, bank levy, or even property liens.
Opportunity for More Federal Aid
Aside from your credit score being affected by delinquent federal student loans, you also are not eligible to receive further federal aid. So if you’re in the middle of pursuing a degree and you are delinquent, then you may not be able to finish (depending on how you look at things, this could be a blessing in disguise, as you likely took on too many loans to begin with).
In order to regain eligibility for federal student loans, the borrower must make 6 voluntary, on-time (within 15 days of the due date), and consecutive payments on their loans.
How to Rehabilitate a Student Loan
If you have defaulted on a federal student loan – meaning you are between 270-360 days late on payments – then you have to rehabilitate the loan in order to continue making payments on it. This is the wonderful do-over I was talking about earlier, as it allows you to get the derogatory mark off of your credit score and essentially start fresh on payments.
In order to rehabilitate a defaulted federal student, you have to do the following:
- Request the rehabilitation through your lender (if your loan has gone to collections, you can still rehabilitate it; if you’re not sure of the collection agency to deal with, then contact your original lender to ask)
- Make consistent, on-time payments in accordance with the rehabilitation agreement (generally over 12 months)
Then, within 30 days after your last on-time payment under the rehabilitation agreement, the lender must return your borrower status to regular repayment status and instruct the credit bureaus to remove the default from your credit history.
Note: If a judgment is obtained on the defaulted federal student loan, then it cannot be rehabilitated.
How Much Does it Cost to Rehabilitate a Loan?
One of the downfalls of rehabilitation is that it is generally not free. Your lender generally has the option to sell your loan to another lender at the end of your rehabilitation period (if you’ve made all the payments per the agreement). It’s at this time that the lender may add a fee onto the cost of the loan, such as a collection cost. Lenders may add up to no more than 18.5% of the unpaid principal and accrued interest at the time of the sale of the loan. It should be noted that sometimes, if you pay the defaulted loan off in one lump sum, the Department of Education opts to waive the collection costs instead of adding it onto the loan amount at sale.
Remember, all this applies to federal student loans and not to private student loans. And of course the easiest way to avoid this mess altogether is to pay your student loans on-time. But it is nice to know that there is a do-over if necessary, right?