Let’s face it, to get though college, a great many of us had to borrow federal student loans. Often we had to borrow more loans that we wanted to. And with the ever increasing cost of school, the amount that students have to borrow is, on average, increasing. Just to get their bachelor’s degree, many students have to take out the maximum each year — which can add up to nearly $45,000 over the course of four years.
Then, once you graduate, you are generally faced with the prospect of a job with minimal starting wages, if you have managed to get a job in your field, and if you are lucky enough to get a job at all.
Or perhaps the school wasn’t for you and you dropped out, or a family emergency came up and you didn’t finish school. Perhaps you received no tangible benefit whatsoever from your education.
At that point it may be very tempting to forget about the loans for a while (or forever) while you concentrate on paying for things like rent and food. You’ll just let the student loan lender worry about them for a while. So what if you default? Federal student loans are guaranteed by the government, and the government will reimburse the lender.
But there are at least seven good reasons why you don’t want to default on your federal student loans:
1) Defaulted loans are more expensive than loans that don’t default.
In general, student loans that aren’t paid promptly when due are more expensive than loans that are paid on time each month because of interest accrual. The older your loan gets, and the longer it goes without payment, the more interest it accrues.
Loans accrue more interest the more forbearances you get. During forbearances, you might be permitted to make smaller or no payments, but interest continues to accrue. (To get deferments, you generally have to meet certain conditions, and you can generally get deferments for only about three years). Then, at the end of the forbearance, lenders typically capitalize, or turn into principal, all outstanding interest. So interest then accrues on a higher principal balance.
In addition to normal loan growth due to interest accrual, there are other costs associated with delinquency and default. If your payment is late, you may have to pay a late fee. Late fees are typically small, such as $5.00, but it all adds up.
But worst of all are the collection fees you’ll be liable for if your loan defaults. Collection fees are typically about 25 percent of the total of the outstanding principal of the loan. In a collection cost lawsuit filed against student loan lenders, it was alleged that some student loan borrowers paid collection costs as high as 30 or 40 percent.
So if a loan defaults, a student borrower, instead of simply paying interest and principal, will end up paying collection fees out of each and every payment.
2) A defaulted student loan can ruin your credit.
If you default on a student loan, it will negatively affect your credit for at least the standard 7-year reporting period, perhaps longer. It will be more difficult, and more expensive, to obtain credit to purchase cars and housing. It may even make it more difficult to rent an apartment or to do anything else that requires good credit.
3) Your tax refunds could be taken to pay your student loans.
If you have defaulted to a state guaranty agency, your state and federal income tax refunds can be withheld and forwarded to that agency. (If you’ve defaulted to the federal government, only your federal income tax refunds can be taken.) If you were depending on that money to catch up on bills or for a special purpose, you could be out of luck.
Please note that this typically can only happen to those who didn’t set up and keep to a repayment agreement soon after the debt defaults to that state or government agency. If you set up payments soon after default, you may be able to avoid such offsets by setting up an agreement as soon as possible. If you start paying soon enough after your debt is placed with a state agency or the federal government, you may even avoid collection costs.
4) Your Social Security benefits could be offset.
This is bad news for those receiving disability or regular Social Security payments. The good news is that, unlike tax refunds, only 15 percent of each payment can be offset. So it may be much easier to bear, unless, of course, your Social Security payment is your only source of income and you already have a tight budget. If the offset causes hardship, you may be able to have it reduced or stopped altogether. Even if this is the case, it will be a great inconvenience to you to have to prove hardship on a regular basis.
5) Your wages can be garnished.
Up to 15 percent of your disposable pay could be garnished in repayment of student loans. Typically, this is done only when other less severe collection measures have failed. Although you cannot legally be fired from your job if this happens, it can certainly cut into the amount of eompensation you receive and could be a great hardship to you if your budget is already tight.
As with the offset of Social Security payments, you may be able to have amount withheld reduced or stopped altogether if you can demonstrate that it causes severe financial hardship.
6) It could be more difficult to get certain other federal loans.
If you want to use a government program (such as Fannie Mae) to help you purchase a house, you may find yourself out of luck until you resolve your student loan default.
7) You won’t be able to get more federal aid for school.
Naturally, you won’t be able to get additional federal student loans for more school if you’ve defaulted on the ones you’ve already received. You won’t even be able to get other federal aid, including grants like the Federal Pell Grant, until you’ve paid the loan off or made a certain number of payments to the lender.
So if you’re thinking about letting those loans default — don’t. Call up your lender and see what kind of repayment, deferment, forbearance, and consolidation options you may have. You’ll be glad you did it.