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What if you default on student loans?

The default rate on federal student loans is higher than it's been in years. For former students, default is no picnic.

By Karen Datko Sep 15, 2010 7:39PM

Former students are defaulting on federal student loans at higher rates -- the highest in more than a decade, according to news reports. What consequences do these debtors face?

It's not pretty. The Washington Post explains:

Default on a student loan and face dire consequences, beyond a bad credit record -- which can tarnish hopes of getting a car, an apartment or even a job: Uncle Sam can claim your tax refunds and wages.

A new U.S. government report says the overall federal student loan default rate was 7% in the 2008-09 fiscal year, compared with 6.7% the prior year and 5.2% the year before that. It's also worth noting that the highest rate and largest increase were among former students of for-profit schools, 11.6% compared with 11% the year before. The New York Times said, "In the 2008-9 award year, students at for-profit schools represented 26% of borrowers -- but 43% of defaulters."

 

NPR added, "Put another way, students at for-profits are twice as likely to default as students at nonprofits." (For-profit schools are quite deservedly getting more government and public scrutiny. For another take, our pal "vh" at Funny about Money shared personal anecdotes about the quality of education, some of which are shocking.)

 

All told, the default numbers are just the tip of the iceberg. The Times also reports:

The default rates represent a snapshot in time, examining only borrowers whose first loan repayments came due from Oct. 1, 2007, to Sept. 30, 2008, and who defaulted before Sept. 30, 2009. Those who defaulted later were not included in the data; over time, default rates increase substantially.

How much? The Chronicle of Higher Education sheds some light on that (note that the figures below quantify numbers of loans -- rather than students -- in default):

According to unpublished data obtained by The Chronicle, one in every five government loans that entered repayment in 1995 has gone into default. The default rate is higher for loans made to students from two-year colleges, and higher still, reaching 40%, for those who attended for-profit institutions.

There are all kinds of reasons why students don't repay their loans, including a terrible job market, inadequate preparation for jobs, and a rising cost of education that has far exceeded the inflation rate.

 

As you already guessed, taxpayers are on the hook when former students default on government loans. So Uncle Sam -- and collection agencies -- will come after you to get the money back.

 

What can happen when you default on a federal student loan? (Note: The rules are different for private loans.)

  • "If you default on your student loan, the maturity date of each promissory note is accelerated making payment in full immediately due, and you are no longer eligible for any type of deferment or forbearance," a U.S. Department of Education website says.
  • Your federal and state tax refunds can be seized, and your take-home pay can be garnished by up to 15%.
  • You won't be eligible for VA or FHA mortgage loans, let alone additional student loans.
  • Part of your Social Security can be seized in your old age. You can't outlive this debt (and bankruptcy usually can't make it go away). However, unlike many private student loans, it will expire upon your death. Disability may also get you off the hook. 
  • You could be sued.  
  • A wretched credit score -- the default can be on your credit report for up to seven years -- carries all kinds of costs, including higher interest rates if you can get loans, and higher insurance premiums.

Sounds dire. Luckily, the government offers several avenues for restoring bad loans to good standing if you contact the lender, which you should do ASAP. They include: 

  • Payment in full. Yeah, right.
  • Consolidation. You can find more information here and here.
  • Rehabilitation -- making nine on-time payments of an agreed-upon amount.

Overall, the process can become complicated, not just because there are so many types of loans. Or so it seems from seven stories of people who defaulted, as told last year on FastWeb.

 

So, default is best avoided. If you can't afford the payments, look into alternate payment plans, forbearance, deferment and consolidation right away. Once the payments come due and you don't pay, you'll be in default in nine months if your payment plan is monthly.  

 

FinAid identifies several other potential courses of action, including this very important one:

Borrow as little as possible. … If your total debt will be more than twice your expected starting salary, you are borrowing too much and should consider attending a less expensive college.

More from MSN Money:

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