Consequences of a Student Loan Default

What happens if you can’t repay your student loans and default? This article explains what consequences you might face and explores the available options.

Student Loans

Student loans are the financial aid you received to attend a college or university. Once you’re no longer in school, you must repay these loans after a grace period. Scholarships and grants are different from loans and do not require repayment. Student loan forgiveness is also available for certain public service, non-profit employees, and teachers.

There are different types of student loans. Federal student aid may include:

• Direct subsidized loans
• Direct unsubsidized loans
• Perkins loans
• Parent PLUS loans
• Grad PLUS loans

Private loans also have different types and can be acquired by the student or a parent to pay for the education costs. If you are unsure what type of loan you have, check with your loan servicer or take a look at your credit report.

What Is a Default?

A student loan default occurs when a borrower fails to make multiple monthly payments on their student loan. The borrower may be responsible for collection fees, late fees, additional interest, and the commission charged by a debt collection agency that purchases the debt.

You cannot apply for new student loans if you have any in default. A default has a negative effect on your credit rating that can follow you through the rest of your life. Getting other loans, such as an auto loan or a home mortgage, may be difficult with a student loan default on your credit report

Delinquency vs. Default

Delinquency begins the first day a borrower misses a payment. The lender will send notices as a warning sign to the borrower, informing them to make up the missed payments before their student loan goes into default. Your default will begin the adding of late fees and penalties to your debt.

If a borrower remains delinquent for nine months (270 days), the student loan enters default. When a student loan enters a default, you are immediately liable for the entire amount of the defaulted student loan. The default appears on your credit history and the lender can begin legal action against you. You no longer have the option to request a forbearance or deferment.

Those in default on student loan obligations may qualify for the Fresh Start program. This program can help bring your loans current, but many of its options expired at the end of September 2024.

Consequences of Defaulting on Your Federal Student Loans

Consequences and remedies for defaulting can vary depending on whether your loan is a private or federal loan.

The federal government has many powers to collect late payments and defaults. The U.S. Department of Education can do any of the following to collect the debt:

Take Your Tax Refund

One of the most effective methods that the Department of Education and loan guaranty agencies use to collect defaulted student loan debt is to seize your tax refund.

The IRS gets an annual report from the Department of Education that contains a list of defaulting student loans. Before the IRS takes your refund, you will receive a notification from the Department or the loan guaranty agency offering the options of paying the debt or appealing the offset.

Unless you appeal, the IRS automatically takes your federal and state income tax refund and applies it toward your loan repayment. A borrower may appeal the offset by asserting one of the following defenses:

• The loan has been repaid
• The loan is being paid under a negotiated repayment plan
• The loan is in deferment, forbearance, or canceled
• The borrower is deceased or suffers from permanent and total disability
• The loan does not belong to the borrower
• The loan is unenforceable because of fraud, such as a forged signature
• The school owes the borrower a refund
• The borrower’s school closed
• The borrower was falsely certified for loan eligibility
• The borrower has filed for bankruptcy, and the case is still pending, or a bankruptcy discharged the loan

The borrower must issue an objection to the offset within 65 days from the date of the notice.

Garnish Your Paycheck

The Department of Education and loan guaranty agencies may also garnish wages to collect student loan debt. They do not need a court judgment for garnishment.

The Department and the loan guaranty can garnish your income in the following manner:

• They can take up to 15% of your disposable income
• This amount must be less than 30 times the federal hourly minimum wage ($7.25 per hour effective July 24, 2009)
• The Department or agency can’t garnish more than $217.50 of a debtor’s weekly income

Before the garnishment, the borrower will:

• Receive notification with information about the garnishment
• Be given the opportunity to repay the debt
• Be given the right to request a hearing to dispute the wage garnishment

If a borrower requests a hearing within the due date specified in the notice, the borrower’s wages are safe from garnishment while the case is under review. Failing to make such a request by the deadline allows wage garnishment may proceed, but it will end if the borrower prevails in a hearing.

Seize Your Federal Benefits

The Debt Collection Improvement Act allows the government to take some Social Security benefits from a student loan borrower in default. The Act has the following key provisions that apply to student loan payments when a borrower defaults:

• Supplemental Security Income is off-limits
• Social Security retirement benefits and Social Security disability benefits can be set aside to pay loan debt
• An annual limit of $9,000 ($750 per month) is eligible, and Social Security benefits remain intact if the borrower receives less than this amount
• The amount cannot exceed 15% of the borrower’s federal benefit

The borrower may object to the offset by requesting a review hearing within the time specified by the notice. A borrower can also request a suspension or a modification due to financial hardship. The borrower must provide documentation, such as proof of yearly income, proof of federal benefit, or a financial statement, at the hearing.

Revoke Your Professional License

Some states allow professional and vocational boards to revoke, suspend, or refuse to certify a license when the member has defaulted on student loan debt. This applies to attorneys, medical professionals, teachers, and state officers. The borrower may request a hearing with the board to review the potential action.

Take Civil Action

The Department of Education can sue to collect on a student loan default. As statutes of limitations don’t apply, the agency has no time limitations on collecting the debt. They can attach lien to your real property and garnish wages to recover the amount owed.

If the borrower does not have enough valuable assets or a lawsuit would exceed the amount recovered from the debtor, the Department will most likely decide against suing the borrower.

Your House, Retirement Savings, or Inheritance

The Department can collect from assets such as bank accounts and valuable property. It can also place a lien on your real property. As a result of such a lien, the borrower may not sell the property until either the lien gets removed or they’re given permission. Any money received from the sale of that property will go to pay for the defaulted loans.

Once it hits your bank accounts, the government may seize an inheritance to meet a judgment against you. However, certain retirement accounts are exempt from seizure.

Private Student Loans

Private lenders will come after you if you default on your private student loan under the Fair Debt Collection Practices Act (FDCPA). Some of the consequences of default include:

• Lower credit score
• A lawsuit against you to garnish your wages or to take money out of your bank account

Your original lender may not contact you. A private lender may sell your account to a debt collector, who then tries to collect payment.

Getting Loans Out of Default

How you can get your loans out of default will depend on the lender. If you defaulted on a federal student loan, here are some of your options:

• Enter a loan rehabilitation agreement, which requires you to make a number of payments for a specific time
• Pay the full loan amount
• Apply for a consolidation loan

If you default on a private student loan, the best option is to negotiate new repayment options with the loan holder.

Student Loan Bankruptcy

In most instances, student loans are not eligible for discharge when you file for bankruptcy. If you have filed Chapter 7 or Chapter 13 bankruptcy, you may ask for special consideration for student loans by filing an adversary proceeding.

You must show the bankruptcy court that paying your student loans is an undue hardship. An undue hardship means you cannot maintain a minimal standard of living for yourself and your dependents because of your loan debts. This hardship will continue for the duration of your repayment period, disrupting your good faith efforts to repay your obligations.

Private loans are easier to have discharged as federal programs offer many repayment options.

Facing a Student Loan Default? Get Legal Help

Defaulting on your student loans can have a devastating effect on your long-term financial health. While you may be unsure how to escape student loan debt, you don’t have to remain in the dark about the laws and your rights. Before your loans go into default, start a conversation with your loan provider. If you’re in default or facing a lawsuit, seek the advice of an attorney experienced in education, bankruptcy, or debt collections.