How to Get Your Student Loans Out of Default (Without Getting Scammed)

Federal student loans have grown to become a national problem, with total amounts far surpassing all other types of non-mortgage debt. Even as auto loan and credit card delinquencies remain at historic lows, student loan default rates have remained a consistent problem despite several attempts by the federal government to offer relief and streamline the application process.

Federal loans make up the vast majority of the nations’ $1.3 trillion student loan balance, and many of the student loans that are listed as current are actually not being paid — due to temporary postponement programs like forbearance and deferment. In the last several years, student loan relief options like direct consolidation and rehabilitation have entered the national discussion more prominently, as people from all walks of life struggle to find the best way to avoid the disastrous consequences of federal loan default.

The application process for these programs isn’t always easy due to an immense federal loan bureaucracy with many moving parts — including loan servicers, guarantors, and collection agencies, which are all involved at different stages in the federal student loan life cycle. Issues with some private companies that are licensed to provide customer service for current borrowers have been well publicized, and although there has been progress on this front in the last several years; too many borrowers still struggle with obtaining the assistance they want through their loan servicers — which can lead to default.

These inefficiencies have created an opening for some third-party student debt relief companies to promote themselves as experts who can help borrowers obtain relief from default, and even forgiveness. This industry has been dogged with allegations of deceit and accusations of even being an outright scam; while industry operatives defend their conduct as a similar service to tax preparation.

However, some of these companies have faced lawsuits from state attorneys’ general and the Consumer Financial Protection Bureau due to deceptive marketing, upfront fees, and needless monthly fees disguised as student loan payments. The last thing a borrower in default needs is to sign up with a deceptive company that can get them in even worse trouble. With so many voices competing for borrowers’ attention and loyalty, the route to a clear financial decision on how to get out of default can become muddled through an overload of inaccurate information.

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Where Do I Get Started?

The first step to getting your federal loans out of default is to take account of your situation and review the types of federal loans that you have, and their status. While you can accomplish this by looking at statements from debt collectors for your defaulted loans, there is a federal loan database known as the National Student Loan Database System that shows all of your loans on the same screen. Since the NSLDS only shows federal loans, it can also be used to determine which of your defaulted loans are private and which are federal, since the private student loans won’t show up.

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To log into the National Student Loan Database, you’ll need to visit www.nslds.ed.gov and set up an FSA ID. The FSA ID is a secure login that is to be used only by individual borrowers to access the student loan websites set up by the Department of Education. The process is relatively straightforward, but for those who aren’t sure how to do it, I created a helpful guide when I set up the FSA ID for my own federal loans.

Once you’ve created your FSA ID, you can now log into the National Student Loan Database and other federal student loan websites. When you log in to the NSLDS, you’ll need to click “Financial Aid Review” and then “Accept”. Then, you’ll be asked to enter your FSA ID, and you’ll see a screen that looks like this:

Screenshot on the National Student Loan Database System

For the purpose of evaluating your loans and comparing payment plans, you’ll mainly want to look at the column with the name of your loans, and the last two columns, which show your outstanding principal and outstanding interest. Not all loans are eligible for certain federal loan relief options, so you’ll want to pay close attention to what types of loans you have. If you see loans that have a $0 balance in the “Outstanding Principal” column, that means those loans were transferred or closed (due to a payoff or a previous direct consolidation, for instance).

When accessing your NSLDS report, keep an eye out for a small red and yellow exclamation point, which would appear next to your loan names in the second column.

This symbol signifies a defaulted federal loan that has been past due for more than 270 days. Defaulted federal student loans are subject to extreme collection measures that private lenders can only dream about. Wage garnishment, tax return offset, and Social Security offset are among the tools the Department of Education has at its’ disposal, and unlike private lenders; the Department of Education does not have to first file a lawsuit to forcibly collect.

As a result of these tactics, the federal government has an extremely high rate of successful collection on defaulted federal loans. It’s best to take immediate action if you find yourself in default, because it’s safe to say that forced collection of some sort is only a matter of time for most defaulted borrowers. Federal loans in default must be brought current before you can apply for a different payment plan or use options like deferment and forbearance.

Are There Really Hundreds Of Different Relief Programs?

One of the questionable claims that some third-party student debt relief companies have made is that there is such a huge amount of federal student loan programs in existence, and that borrowers couldn’t possibly evaluate and apply for them on their own without spending hours upon hours researching and evaluating every available plan. While there are many different types of relatively obscure state-based federal loan programs, including the New York State Licensed Social Worker Forgiveness Program, or the Alaska Supporting Health Care Access Through Loan Repayment program; there is a much smaller pool of programs that make up the main options and payment plans for federal loan relief.

There are two main programs available to get your federal loans out of default — direct consolidation and rehabilitation. They both have benefits and drawbacks, but in general, either one is better than staying in default and risking potential wage garnishment or tax offset.

Direct Consolidation

About the program: Direct consolidation is a free federal program that results in the Dept. of Education paying off old loans, and creating a new direct consolidation loan with the same balance (including any late fees and accrued interest for defaulted borrowers) and a weighted average of the interest rates (rounded up to the nearest 1/8^th of a percent) on the loans you included. When using direct consolidation to get out of default, you’ll need to also apply for a payment plan related to your income in order to complete the process. Consolidation is not the same as refinance and does not lower interest rates.

How to apply: Studentloans.gov, or via paper application completed and sent to one of the four main federal loan servicers.

Why should I apply: To simplify repayment for student loan borrowers with multiple loans through different loan servicers; to convert different types of federal loans (such as Federal Family Education Loan) into Direct Loans in order to be eligible for other relief programs; to get out of default.

When should I apply: Borrowers often apply when they are starting repayment if they have multiple loans through different servicers after graduating. If you use this method to get out of default, it should be done as soon as you choose it as the best option to get out of default, since waiting too long to take action on a defaulted loan can result in wage garnishment — at which point it is no longer possible to consolidate out of default.

Pros: Direct Consolidation can help simplify repayment and ensure eligibility requirements are met for other relief options that are only available for Direct Loans, like the Public Service Loan Forgiveness program. For borrowers in default, loans can become current within 2-3 months after applying — without having to make any payments on their defaulted loans. Direct consolidation can be done by the borrower directly and does not need to be initiated by a collection agency or loan servicer. Not every type of federal loan qualifies for direct consolidation, but most do. A direct consolidation can also stop a tax offset from occurring in the future, and defaulted federal loans undergoing tax offset are still able to go through the Direct consolidation process.

Cons: One of the downsides of Direct Consolidation is that it can remove loan specific benefits a borrower may have. It also removes the ability to use a strategy where you pay down a smaller loan first, or a loan with a higher interest rate first. All included loans will be combined into the new direct consolidation loan at a weighted average of the interest rate, which is rounded to the nearest 1/8^th of a percent. By using auto-debit payments with your loan servicer, it’s possible to lower interest rates by 1/4^th of a percent, which can offset the increase that occurs when the weighted average of your interest rates is rounded up.

For those who use direct consolidation to get out of default, any accumulated late fees and interest will be added to the new consolidated balance. Not all loans are eligible for direct consolidation, including loans that are undergoing administrative wage garnishment. If you have a previous direct consolidation with no other loans to add, then you cannot go through the direct consolidation process again. However, you can use direct consolidation on a previous FFEL Consolidation, even if it’s just a single loan.

Rehabilitation

About the program: Rehabilitation generally consists of making 9 out of 10 months of payments to a collection agency in order to bring defaulted loans current again. “Rehab” does not create a new loan like direct consolidation does — it brings the old loan back to a current status. The payments while on “Rehab” are the same as they would be under the income-based repayment plan, so they are set to 15% of your discretionary income.

If your income is very low, payments on rehabilitation can be as little as $5 per month. One of the benefits of rehabilitation is that a successful completion of the program results in the removal of the default notation from your credit report. Some collection agencies are also authorized to remove accumulated default fees (which can total 18% or more of the loan balance at the time of default). You can view two free credit scores from Credit.com each month as you’re finishing up the rehabilitation process to monitor any changes to your credit from the removal of the federal loan default notation.

How to apply: You must contact the collection agency assigned to your defaulted federal loans to start the rehabilitation process.

Why should I apply: Rehabilitation requires a significant amount of monthly payments, but it can be a good alternative to direct consolidation for getting out of default due to the removal of the default notation and potential removal of collection fees.

When should I apply: After evaluating the other option to get out of default (direct consolidation) and choosing which option is best for your circumstances.

Pros: Removal of default notation from credit reports; possible waiver of collection fees; and the potential for a low monthly payment, particularly for low-income consumers, since this charge is based on the income-based repayment scale/formula. Rehabilitation can be used to get a loan out of administrative wage garnishment.

Cons: Rehabilitation is a great program on paper, but some collection agencies have run into difficulties properly implementing and explaining it to borrowers. The length of the program can create an obstacle for borrowers who need to get their loans current as soon as possible, for reasons such as returning to school or applying for a job-based security clearance. Even though the program was modified in 2014 to formulate payments on the income-based repayment scale, payments can still be high for borrowers who have significant income. Although the default notation is taken off of your credit report after completion of rehabilitation, the late marks leading up to the default can remain.

By understanding the framework and a basic summary of the main defaulted federal loan relief options, graduates can plan their path out of student loan purgatory and gain access to the many different programs available to borrowers in good standing — like deferment, income-driven payment plans, and even forgiveness. Besides direct consolidation and rehabilitation; borrowers can also become current by paying a settlement or by paying their loans in full. Settlements are very limited with federal loans and often just result in the removal of fees, with occasionally some interest removed. It is very rare for any principal to be removed due to a federal loan settlement.

Federal loan relief programs are not one size fits all, and they should be looked at as individual tools in the borrowers’ student loan repayment toolbox. Of course, the best way to deal with a potential default is to prevent it from happening in the first place, which can be accomplished by applying for an affordable payment plan related to your income before you become 9 months past due.