Will Student Loan Rehab Fix Your Credit?

When Lionel Alexander rehabilitated his federal student loan he thought his credit would get back on track. After all, that’s one of the promises of federal student loan rehabilitation: that the default will be removed from the borrower’s credit reports.

Student loan rehabilitation is a process that allows borrowers who have defaulted on federal loans to make reasonable and affordable payments to get them out of default. It usually requires the borrower to make nine consecutive payments on time.

What he didn’t know is that there is a hidden trap when it comes to student loan rehabilitation and credit reports. While the notation about the default will be removed from the borrower’s credit reports upon completion of the program, late payments leading up to that point may remain for seven years and continue to severely hurt the borrower’s credit.

Alexander feels misled. He acknowledges that he was told that the default would be removed if he rehabilitated his loan. “And that’s pretty specific in hindsight”, he says. “But when you first get that agreement, all it says to the layperson is that you are going to be fine afterward.”

“We agree that loan holders and collectors tend to oversell the benefits of rehabilitation,” says Deanne Loonin, staff attorney with the National Consumer Law Center. The organization recommends “full credit repair relief “ in a policy brief published by its Student Loan Borrower Assistance project.

No News Isn’t Good News

Alexander defaulted on two student loans in early 2011. Shortly after he defaulted, though, he was able to come up with a plan to pay them back. One loan, with Sallie Mae, had been turned over to the Louisiana Office of Student Financial Assistance. The other loan was through the University of New Orleans.

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Lionel Alexander

He made the required payments on both loans for nine months and at the beginning of 2012 received letters saying that his loans had been successfully rehabilitated. “I just assumed everything was fine,” he says.

It wasn’t until the summer 2012 that he signed up for a credit monitoring service and was shocked to discover a lot of negative information still on his reports. In fact the Sallie Mae loan was now reported three times: first under the original loan with Sallie Mae, then with the servicer that handled his loan while in default, and finally with the new servicer he was paying post-rehabilitation.

More disturbingly, Sallie Mae was still reporting the default, which should have been removed by then.

He wrote a letter to Sallie Mae but they refused to correct it. Recently, he says he “decided to take up the fight again.” He sent another letter, and followed up with a phone call that lasted two hours. He knew his rights, and insisted they at least remove the default notation. “Over the phone they still refused to amend any part of the reporting of the loan,” he explained in an email, “but then a week later, I checked my daily Experian credit report and saw that they’d amended the loan’s status to “Unknown” and removed the default and the government claim remarks, instead remarking now that the loan had been ‘transferred to another office.’”

Fortunately, his other lender was more accommodating. Upon his request, all negative information related to the University of New Orleans loan was removed.

But the Sallie Mae loan still shows 90- and 120-day late payments which are dragging down his credit scores. Even though the default was removed, Alexander says those late payments mean “my credit score didn’t really rise, so it really didn’t benefit my credit.”

He is now in the process of getting ready to launch a food truck next year. He has saved a considerable amount of money but will still need a loan and he’s concerned his credit will be a deal-breaker.

Student Loan Borrowers Beware

There can be very good reasons to rehabilitate a federal loan and get it out of default. For example, the borrower may be able to get into a more affordable repayment program once that process is completed. And it can restore their eligibility for federal student aid.

However, if borrowers are hoping their credit scores will improve, they may be in for a rude awakening.

Student loan borrowers can find out how their loans are affecting their credit scores by getting a free credit score at Credit.com. It will include analysis of the factors affecting the score.