With default rates on federal student loans rising, this information about rehabilitating your defaulted loans from Creditcards.com might come in handy for many:
Because your loans are in default, you've been experiencing the "awful" end of the spectrum -- so let's get you back to the "great."
First, know that unemployment benefits are usually exempt from wage garnishment for federally guaranteed student loans, despite what the collector said. Of course, when you do resume employment, the garnishment will probably begin again, and if the collector chooses to sue you for the balance, then yes -- depending on the state you live in -- 25 percent of your new net wages may be siphoned off to go toward debt.
You said you tried to negotiate to no avail. I believe it. The collectors don't have to accept anything less than the total balance due because they can pursue you pretty much forever. This puts them in a pretty powerful position.
Now it's time to reclaim your own power. As per the Higher Education Act, borrowers in default have the right to cure their defaulted student loans by setting up a "reasonable and affordable" payment plan with whoever is holding them. This is a one-time only chance to cure the default by making a total of nine consistent and consecutive payments that are within your means.
So who decides what is in your means? You do. Sure, the collectors would like a regular $175, but if that figure isn't feasible, it really is your call.
To set this plan up, do the following:
- Review your budget in detail to determine exactly how much you can afford to send each month.
- Contact the collection agency and let them know you understand your legal right to rehabilitate your student loans and that you intend to arrange a "reasonable and affordable" payment plan.
- State your proposed monthly payment. Though they may balk and request that you complete a U.S. Department of Education Financial Disclosure Statement to prove financial hardship, in the end, they have to accept it.
- Write a letter detailing your offer, and add any supporting documentation. As with all important correspondence, make and keep copies of everything for your records, and send the letter certified mail, return receipt requested.
- When they accept the plan, read their agreement letter carefully before signing.
- Then, start to pay.
Upon completion of nine steady, on-time payments, your loan will be cured and the default notation removed from your credit reports. Don't assume your credit will be perfect after this, though. It won't. "The delinquencies that led up to the default will remain for the normal seven years," says Betsy Mayotte, director of regulatory compliance and privacy for American Student Assistance in Boston.
When the loans are rehabilitated, they'll be taken out of collections and resold to a lender, and you'll be placed back on the standard 10-year payment plan. If your payments on the "reasonable and affordable" plan had been tiny, they will increase substantially. However, says Mayotte, you can apply for other more affordable arrangements, such as the income-sensitive plan, which is tailored to your cash flow."
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This article didn't discuss the other option to cure a defaulted loan which is consolidation. Since it only requires "three reasonable and affordable payments," consolidation may be a more attractive option for defaulted borrowers but be sure to compare both and see how they fit with your personal situation.
For more information on curing defaults through consolidation, I turned to Student Loan Borrower Assistance which provides detailed information on managing post-default federal student loans either through consolidation or rehabilitation. Here are some of the details about how to cure a default situation through consolidation:
What are benefits of consolidating to cure a default situation?
"Consolidation works well for many borrowers with defaulted loans. After obtaining a consolidation loan, you get a fresh start, becoming eligible for new loans, grants, and even deferments. You will no longer be listed as currently in default on your credit records, and no longer subject to tax intercepts, garnishments, or other collection efforts."
What are requirements if I have defaulted Direct Loans?
"If you are in default and consolidating with Direct Loans, you must either make three reasonable and affordable payments or agree to repay using the Income Contingent Repayment Plan (ICRP) or the Income-Based Repayment Plan (IBR). The Department is currently taking the position that you can only select IBR after you have already consolidated your loan. The repayment plan selection form for borrowers consolidating defaulted loans has a check box for ICR, but not IBR. At this point, if you are in this situation, you must complete the paperwork for ICR. Once this loan is approved, you can then request a switch to IBR. Until the IBR plan is approved, you will continue to owe the ICR payments. If you cannot afford these, you should request forbearance or deferment until the IBR plan is approved."
What if I have defaulted FFEL loans?
You are also eligible [for Direct Loan Consolidation] if you have only FFEL loans as long as you meet one of the following two conditions: 1) You must be unable to obtain a FFEL Consolidation loan or 2) unable to obtain a FFEL Consolidation loan with acceptable income-sensitive repayment terms. Despite what a FFEL lender might say, you do not have to actually apply for a FFEL consolidation loan before applying for a Direct Loan consolidation. [Note: I am not aware of any FFEL lenders currently providing federal loan consolidation].
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Here is what the Department of Education site says about improving your credit report:
"Failure to repay your defaulted student loan can be damaging to your credit record. In fact, consumer reporting agencies may continue to report an account for 7 years from the opening date. However, there are several things that you can do to at least partially, and in some cases, fully restore your credit record. Your options for bettering your credit report include: repay or satisfy the loan in full; consolidate your loan through the FFEL loan consolidation program or the William D. Ford Direct Loan Program; or rehabilitate your loan through our loan rehabilitation program.
If you want the negative credit report made by the Department removed, you must successfully complete our loan rehabilitation program."
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