Student loans can be a huge financial burden, but defaulting on a loan can result in even bigger money headaches.
College-bound students and their families should research the different student loan options available in order to make the best decision for their financial future.
It's important to borrow loans with terms that allow flexibility for repayment to avoid falling into delinquency or default.
What is delinquency?
A loan becomes delinquent after the first day there is a missed payment, according to the U.S. Department of Education.
Even if you miss only one monthly payment, then start making payments again, an account will remain delinquent until the past due amount is paid or other arrangements are made, such as deferment or forbearance. If you are more than 90 days late on a student loan payment, the lender reports the delinquency to all three major credit bureaus.
This is when a delinquency starts to affect your financial future. Delinquency marks on your credit report can significantly lower your score and negatively affect your finances.
Poor credit scores can affect your ability to qualify for credit cards, home and car loans and other forms of consumer credit. You can also have trouble signing up for utilities, getting a cell phone plan or getting approved for an apartment rental.
What is default?
If a loan continues to be delinquent, it can go into default. The time it takes for a student loan to go into default depends on the loan type. According to the Department of Education, Direct Loans take about nine months to go into default, while a Federal Perkins Loans can go into default if you don't make any scheduled payment by the due date.
The consequences for going into default are severe. The Department of Education website lists the following:
- The entire unpaid balance of your loan and any interest you owe becomes immediately due, known as "acceleration"
- You can no longer receive deferment or forbearance, and you lose eligibility for other benefits, such as the ability to choose a repayment plan
- You will lose eligibility for additional federal student aid
- The default will be reported to credit bureaus, damaging your credit rating and affecting your ability to buy a car or house or to get a credit card
- Your tax refunds and federal benefit payments may be withheld and applied toward repayment of your defaulted loan. This is known as a “Treasury offset”
- Your wages will be garnished. This means your employer may be required to withhold a portion of your pay and send it to your loan holder to repay your defaulted loan
- Your loan holder can take you to court
- You may not be able to purchase or sell assets such as real estate
- You may be charged court costs, collection fees, attorney’s fees, and other costs associated with the collection process
- It may take years to reestablish a good credit record
- Your school may withhold your academic transcript until your defaulted student loan is satisfied. The academic transcript is the property of the school, and it is the school's decision—not the U.S. Department of Education’s or your loan holder’s—whether to release the transcript to you.
You should avoid going into default and speak to your school or lender about repayment options before going into default. The U.S. government is very good at debt collecting and will find a way to get their money paid.
What happens when you default on a private loan?
Consequences for defaulting on a private loan may be different than the ones listed by the Department of Education but are just as severe. When a borrower takes out private student loans, default is explained in the terms.
Unlike federal lenders, private lenders have to go to court to get a money judgment against you before using collection tools such as garnishment, according to Nolo.com.
A lender has to file a lawsuit in order to obtain a money judgment and can only do so by proving the borrower is in default and that they signed a promissory note held by the lender.
Private lenders usually try to get you to pay your loan before going to court by calling and sending letters. Once a money judgment is granted, a lender can collect their money through means of garnishment, placing liens on personal property and real estate and by freezing and garnishing your bank account.
Private lenders often hire collection agencies to try and collect your debt and unlike federal student loans, private loans are not dischargeable in bankruptcy.
Since private loans often require a co-signer, collectors could start seeking payments from the co-signer, although the borrower is still responsible for the debt. The co-signer could also be sued and their assets could also be at risk of having liens placed.
Private lenders can also place collection fees on the student loan which could significantly increase the loan balance.
Unlike federal loans, private loans are subject to the statute of limitations, meaning that if a lender hasn't filed a lawsuit after a certain period of time, you may be off the hook. The time period varies from state to state.