Defaulted Student Loan FAQs
What does it mean to default on a student loan?
For federally guaranteed student loans under Title IV of the Higher Education, a default occurs when you fail to make payments on your loan for (a) 180 days if you repay in monthly installments or (b) 240 days if the payments are due less frequently. During the time that you are behind in your payments, your lender must exercise “due diligence” (make repeated efforts to find you and contact you about repayment) in attempting to collect the loan from you. If the lender is unsuccessful, it will usually place the loan in “default” and turn it over to the “guaranty agency” in your state. Lenders may “accelerate” a defaulted loan, which means that the entire balance becomes due in a single payment.
Once your loan is assigned to a guaranty agency or the U.S. Department of Education for collection, several steps, including the following, may be taken to recover what you owe:
* credit bureaus may be notified [under 20 U.S.C.1080 or 20 U.S.C. 1087cc (c)] and your credit rating may suffer,
* the IRS (under 34 CFR 30.20-30.33) may withhold your tax returns,
* you may be subject to an Administrative Wage Garnishment where the Department of Education ( under 20 U.S.C. 1095a), will require your employer to forward 10-15% of your disposable pay for repayment , or
* the Department may take legal action to force you to repay.
Once a loan is declared in default, you are no longer entitled to any “deferments” or “forbearances” (explained below). In addition, you may not receive any additional Title IV federal student aid if you are in default on any Title IV student loan.
How can I escape default?
There are generally three things to do to avoid or escape defaulting on a student loan when you are unable to pay. They are:
1. cancel or discharge (end your obligation to repay) the loan,
2. renew or consolidate the loan into a new loan, or
3. file for a deferment or forbearance
When can I cancel or discharge a student loan?
All student loans authorized by Title IV of the Higher Education Act can be canceled if you die or become permanently and totally disabled [but you cannot be considered disabled on the basis of a condition that existed when you applied for the loan unless it has substantially deteriorated, 34 CFR 682.402 (e)]. Stafford, PLUS, and SLS loans disbursed ( given to you) after January 1,1986, can be canceled under two additional circumstances:
1. the school you attended improperly certified your ability to benefit from the training given, or
2. the school you attended closed while you were in attendance or within 90 days after you withdrew from the school.
In addition to the above four reasons, a National Defense Student Loan can be canceled if you enter into full-time teaching or military service. A National Direct Student Loan and a Perkins Loan can be at least partially canceled under two more additional circumstances: becoming a Head Start Program Staff Member or a Peace Corps Volunteer. A Perkins Loan can be at least partially canceled under 5 different additional circumstances:
1. As a Peace Corps or VISTA Volunteer,
2. As a full-time law-enforcement or corrections officer for loans received after 11-29-90
3. Entering a full-time teaching position
4. Becoming a full-time nurse or medical technician for loans disbursed after 7-23-92, or
5. As a full-time employee of a public or private nonprofit child or family services agency if your loan was disbursed after 7-23-92.
Can I discharge a student loan in bankruptcy?
Under certain circumstances you can discharge your obligation to repay a student loan in bankruptcy. The criteria are set out at 11 U.S.C. 523 (a) (8). Currently your loan may be discharged only if the first payment became due on the debt at least seven years before the bankruptcy was filed.
Any grace periods, forbearances, or deferments must be subtracted from the time elapsed between when the first payment became due and the filing date. Loans outstanding for less than the required seven-year period can be discharged only if the bankruptcy court makes an express finding that repayment would place an “undue hardship” on you.
If your obligation to repay a student loan is discharged in bankruptcy, any co-signers or endorsers of your debt are not discharged. For example, if your parents co-signed your student loan, they are still liable for repayment.
How do I apply to cancel or discharge my loan?
First find out who is currently holding your loan. Check the collection notices that you have been receiving. Additionally you may call the Federal Student Aid Information Center at 1-800-433-3243 (1-800-04-FED-AID ). If the guarantor agency has the loan you should deal with it. If the Department of Education is holding the loan, deal directly with the Department. If the Department has referred your loan to a collection agency, inform the agency in writing that you are contesting the debt by filing for a discharge of the Department of Education. If you defaulted on a Perkins Loan, it may still be held by your college and you should contact it for more information.
To apply for discharge or cancellation you must submit a written request with a statement made under penalty of perjury indicating:
* that you received at least part of your loan after 1-1-86, and
* whether you have made a claim relating to the loan to the a state tuition coverage program or surety for the school, and so, the amount of any recovery, and
* that you agree to cooperate with the Department in any action to recover money related to the loan from third parties (like school-owners or their affiliates), and
* you agreed to provide other reasonably available documentation, if requested.
You will also have to attest to other matters specific to the reason you are seeking the discharge. For example, you will have to give information regarding school closing or false certification if you are seeking cancellation on either of those grounds.
Who qualifies for discharge due to school closure?
If your school (or the branch which you attended):
1. closed while you are still either
2. enrolled or
3. on an approved leave of absence, or
4. you withdrew from the school within 90 days of its closure, you may qualify for discharge. 34 CFR 682.402 (d). After the school closed, you must not have completed the program of studies through a “teach out” at other school or by transferring academic credits or hours earned at this closed school to another school.
A school’s closure date is the date when it ceased offering all programs, not when it stops offering the particular program in which you were enrolled. The Department of Education determines the closure date, which you can find out from Department\’s Cumulative List of Closed Schools. The Department’s list is not always accurate so you may have to prove an earlier closing date by newspaper accounts, correspondence with the school, etc.
If your loan is discharged, you will owe no more payments, You will get a refund of past payments. Moreover, the servicing agency will tell credit reporting agencies that the loan was discharged. Any bad credit history should be deleted. You can now apply for more federal student financial aid. The full criteria for a closed school discharge may be found at 34 CFR 682.402 (d).
Who qualifies for discharge due to false certification?
If you were admitted to a school in without a high school degree after 7-1-87, you are generally able to get a false certification discharge. The Department will find the school falsified your ability to benefit in the program unless you did one of the following:
1. passed an “ability to benefit” test approved by the Department (or prior to1991 by an accrediting agency) that was administered properly,
2. successfully completed a program of developmental or remedial education provided by the school, or
3. enrolled before 7-1-91 and received at GED before completing your program of instruction.
If your loan is discharged, you will owe no more payments, you will get a refund of past payments. Moreover, the servicing agency will tell credit reporting agencies that the loan was discharged. Any negative credit history should be deleted. You can now apply for more federal student financial aid. The full criteria by which borrowers may qualify for a false certification discharge may be found at 34 CFR 682.402 (e).
If I cannot discharge my loan but cannot afford the payments, what can I do?
The federal government offers two types of consolidation loans to allow students for students to combine different types of federal loans to reduce and simplify payment. The two programs are a Federal Family Education Loan (FFEL) and the Federal Direct Consolidation Loan (hereafter, Direct Loan). Generally, the Direct Loan offers more generous terms for the borrower.
The Direct Loan is designed for those who can afford to repay their existing student loans. Borrowers make monthly payments based on yearly family incomes. Borrows with family annual incomes of less than $900 above the poverty level need not make any payment on the loan.
Once you get the loan, the old loans disappear. You are eligible for new loans, grants, and deferments. You will no longer be listed as in default on credit records, and will not be subjected to tax intercepts, garnishments, or other collection efforts. The Direct loan has several advantages over the FFEL. Included are:
* it is easier to qualify because it is unnecessary to make three regular payments before qualifying as is required to obtain a FFEL,
* the Direct Loan offers lower payments than a FFEL,
* borrowers with Direct Loans may be in a better position than those with FFELs in seeking deferments
* Direct Loans offer somewhat lower interest rates over the life of the loan that those offered by a FFEL
Some Direct Loan borrowers, due to their low incomes, may be making no or very low payments. These low payments may not cover accrued interest. The amount of the loan is increased to include the unpaid interest. After interest is charged on the accrued interest, the loan balance can increase significantly. There are some positive features of the Direct Loan program; however, than offset some of these negative facts. They are:
* borrowers may seek loan deferments during which period, the government pays the accrued interest,
* a cap is placed on interest to keep it under control,
* after 25 years of payments (even if payments were zero over the entire time period) the loan is forgiven. However, periods of deferment or forbearance, during which the borrower is excused from making payments, are not counted. Note: when the loan is forgiven, the amount of the loan has to be counted as income on your tax return.
What is a FFEL and what should I know about it?
Like the Direct Consolidation loan, the FFEL if helps borrowers consolidate several loans with various repayment schedules in one loan. You make only one monthly payment. Under the program, the new loan will be made by a commercial lender. Credit bureaus will be notified that your account has a zero balance. You will sign a new promissory note with a new interest rate and repayment schedule.
To qualify you must first be in “repayment” status on your defaulted loan (that is, you must make three voluntary, on time, regular monthly payments). You become eligible for other federal loans. As with the Direct Consolidation Loan you must give your consent to the IRS to disclose to the Department of Education certain income tax information. This information is necessary in order to calculate a monthly repayment plan based on your income which you must agreed to accept.
The monthly payments on a FFEL must, at a minimum, equal all interest as it accrues, while Direct Loan monthly payments may go as low as zero. An order to receive a Direct Loan you must certify that you the there could not obtained and FFEL or get one with a repayment plan satisfactory to you.
Are there disadvantages to getting a consolidation loan?
There are some disadvantages to getting either type of federal consolidation loan. As noted above, you may be able to bankrupt your student loan seven years after the first payment became due. A loan consolidation may start the seven-year time period running again. Moreover, if you are considering challenging the loan, a consolidation loan may waive some defenses if you later contest the loan in court. If you believe you may be going to court to fight against a loan, or are considering bankruptcy, you should consult a lawyer before applying for consolidation.
Another disadvantage of consolidation is that while you cure the default by consolidating a loan, your credit continues to show that at one point you were in default. . If you “rehabilitate” a loan instead, any reference to the default is removed. Also after consolidation collection fees become part of the loan principle.
Finally, borrowers may have more opportunity to compromise the amount owed on old loans than on a consolidation loan. To compromise the amount owed means you negotiate repayment of lower amount than the total owed. However, this usually requires a lump sum payment of a major portion of the loan. Most low income people cannot afford the lump sum payment.
Is there any way to temporarily stop making loan payments?
There are two ways to temporarily stop making payments and/or to avoid a default. You may request the Department of Education to grant you a “deferment” which allows you to stop payments (and stop interest from accruing as well). You must meet specific criteria in order to qualify for a deferment. You may request the guaranty agency for a forbearance of payments for short period when poor health or personal problems which affect your ability to pay. Interest continues to accrue during forbearance.
What are the criteria for obtaining a deferment?
There are two sets of standards for obtaining deferments. The old standards applied to loans disbursed before 7-1-93. The new standards which are somewhat more generous applied to loans disbursed after 7-1-93.
Some of the more important grounds for deferral of loans disbursed prior to 7-1-93 are:
* unemployment (maximum of two year deferment),
* full-time student at participating school,
* active duty status in the U.S. Armed Forces,
* receiving, or being scheduled to receive service, under a program designed to rehabilitate disabled individuals,
* temporary total disability,
* providing nursing or similar services to a spouse who is temporarily totally disabled,
* parental leave, and
* being a mother of preschool children starting work at no more than $1.00 above the minimum wage
The standards for loans disbursed after 7-1-93 are somewhat more generous. The maximum unemployment deferment period is increased from two to three years. The old three-year deferments for specified types of financial hardship ( temporary total disability, taking care of a disabled dependent, parental leave, and mother with preschool children making slightly more than wage, etc.) are placed by a new three-year deferment category called “economic hardship”. If you receive public assistance, you automatically qualify. If you do not, the Department will apply a complicated formula to decide if you qualify.
How can I obtain forbearance on my loan?
The Department encourages lenders to grant forbearance if you are in poor health or other personal problems affect your ability to make scheduled payments. Forbearance is not as helpful as a deferral because interest continues to build while the loan payments are reduced or postponed. The size of the outstanding debt could actually increase during a forbearance period. However, forbearance is not available when the loan is in default. Seeking forbearance would allow you to avoid default during the time in which you cannot afford to make payments.
Lenders must grant forbearance when your debt exceeds 20% of your gross income and you submit a written request. Under those circumstances a lender must grant forbearance for one year and shall renew it for a second and third year under certain conditions. Moreover, the fact that you are granted forbearance cannot be the cause of a negative credit report and no fees can be charged. Unfortunately this right is limited to loans held by lenders. It does not apply if the loan has been taken over by guaranty agency or the Department.
Default & Consequences
DEFAULT: FFEL and Direct Loans: Failure to make required payment when due, if failure persists for 270 days: FFELP (20 U.S.C. § 1085(l); 34 C.F.R. § 682.200(b), and Direct: 34 C.F.R. § 685.102(b). Holder always accelerates the debt promptly after default.
Perkins: Failure to make a payment when due: Perkins: 34 C.F.R. § 674.2(b); school may later accelerate the debt.
CONSEQUENCES:
Credit bureau reporting and use of collection contractors: Holders of loans in all three loan programs must report the debt as delinquent or in default to national credit bureaus, and typically use collection agency contractors to perform collection activity after default.
Liability for collection costs: The HEA makes defaulters liable for “reasonable” collection costs. 20 U.S.C. § 1091a(b)(1). FFELP regulations direct each guarantor to compute “reasonable costs” using a “make-whole” method that computes the charge to each defaulter on the model of a guarantor-specific contingent fee. The charge to each defaulted FFELP debtor is assessed as a percentage of the loan balance, with that rate set to generate funds sufficient to reimburse the guarantor for the costs of collection efforts on its entire defaulted loan portfolio – not just on that individual loan. 34 C.F.R. § 682.410(b)(2). The regulations require the guarantor to offer the defaulter a brief initial opportunity, after the default claim is paid, within which the debtor can agree to repay voluntarily, without liability for costs. (34 C.F.R. § 682.410(b) (5)(ii).
Limits on Collection costs: The guarantor’s collection cost charge is capped at the amount Education would charge if Education rather than the guarantor held the loan – currently 25% of principal and interest. (Note that regulations mandate a lower cap – 18.5% – for payoffs by Consolidation, 34 C.F.R. § 682.401(b)(27) or rehabilitation transfers, 34 C.F.R. § 682.405(b)(1)(iv)).
BANKRUPTCY
Bankruptcy – Who’s got the ball?
When a borrower files for relief in bankruptcy, how HEA loans are handled, and by whom they are handled, differs depending on the type of loan, the type of bankruptcy filing, who held the loan when the debtor filed, and whether the loan is already in default when the petition for relief is filed. In each case, follow the money and the identity of the holder will become apparent:
For FFELP loans:
Chapter 7 and 11: The lender (bank or secondary market) that holds a FFELP loan must file a proof of claim, but retains the loan through the bankruptcy unless and until the debtor files an adversary seeking a dischargeability determination under 11 U.S.C. § 523(a)(8). The holder then files a claim with the guarantor on the loan guaranty, and assigns both proof of claim and the loan to the guarantor. Education reimburses the guarantor for the full amount paid to the lender on the claim.
The FFELP rationale never imposes on lenders any obligation to litigate or deal with litigation of any kind.
Chapter 12 and 13: The lender must suspend collection efforts, file a proof of claim in the bankruptcy, and then promptly claim on the guaranty and assign both the loan, and the proof of claim filed on the loan, to the guarantor. The guarantor pays the lender on the claim. Education reimburses the guarantor for the full amount paid to the lender on the claim.
In all cases, after taking assignment, the guarantor is responsible for defending the debt against discharge. For State guarantors, this duty may be accomplished by raising sovereign immunity as a defense to adversary proceedings claiming undue hardship.
Non-defaulted FFELP loans held by guarantor: After the bankruptcy case is closed, either by dismissal or general discharge order, the guarantor must put any non-defaulted loans back to the claiming lender, or must sell the loan to another eligible lender, and must repay to Education any amount received from Education as Federal reimbursement for a claim on that loan.
The loan is treated as in forbearance during the stay period by the original lender (if that party holds the loan through the bankruptcy proceeding) or the purchasing lender. 34 C.F.R. § 682.402(f)(5)(ii). Interest accrues during this period and is capitalized unless paid as it accrues. 34 C.F.R. § 682.402(j)(2).
Defaulted FFELP loans held by guarantor: If a FFEL loan is already in default and held by the guarantor when the borrower files in bankruptcy, the guarantor must file a proof of claim that includes, in the amount in the proof of claim, a claim for collection costs, computed by the make-whole method described earlier. When the case is closed, the guarantor resumes collection activity on the loan.
Perkins Loans: The school similarly retains Perkins loans through the bankruptcy process, and like a FFELP guarantor, is responsible for defending the debt against discharge. For State postsecondary institutions, this duty may be accomplished by resisting undue hardship claims on sovereign immunity grounds. After the case is closed, either by dismissal or general discharge order, the school resumes collection action. The loan is treated as in forbearance during the stay period. Interest accrues during this period and is capitalized unless paid as it accrues.
FORBEARANCE & DEFERMENT
Borrowers facing financial difficulty in meeting repayment obligations can switch to another repayment plan available for their kind of loan, or suspend or modify that repayment schedule by means of deferments or forbearances.
• Deferment is a suspension for specific causes of the obligation to repay; the borrower is entitled to a deferment upon demonstrating that qualifications are met.
• Forbearance is a temporary modification of an established repayment schedule either for inability to meet the existing repayment obligations or other specified grounds. Forbearances can suspend all repayment, or can temporarily reduce the required installment amount. Generally, forbearances are within the discretion of the lender and are not a right of the borrower.
A. General comments on deferments and forbearances
• Deferments and forbearances are available prior to default and after rehabilitation, (which cures default – see below), but not while the loan is in default.
• Deferments: for those FFEL and Direct loans based on financial need, government will pay the interest accruing during deferments. Other FFEL and Direct, borrower is liable for accruing interest (can be paid as accrued or capitalized).
• Forbearances: debtor must pay the interest prior to end of forbearance or it is capitalized (added to principal balance)
• Whether particular type of deferment or forbearance is available depends upon many factors, including when the loan was taken out and if borrower had prior loans
• In general, borrower is limited to up to maximum of three years per type of deferment. Forbearances may be granted for up to one year at a time, but FFELP regulations do not limit the cumulative amount of forbearance periods.
Deferments:
Regulations:
Authority: FFELP – 34 C.F.R. § 682.210; Direct – 34 C.F.R. § 685.204; Perkins/NDSLP – 34 C.F.R. § 674.34 et seq. Each program has a variety of deferment grounds; several are focused on financial hardship, including unemployment deferment and economic hardship deferment.
1. Economic Hardship Deferment: available under all Title
IV Loan Programs; 34 C.F.R. § 682.210(s)(6) (FFEL); 34 C.F.R. §685.204(b)(3) (Direct); 34 C.F.R. § 674.34(e)(Perkins). Borrower must be —
a. receiving public assistance, or
b. working full-time (30 hrs/wk or more) with low income – at or below the HHS Poverty Guideline amount for family of two [for 2004, $1040.80 per month], or
c. working full-time, with high debt/income ration: (monthly income – student loan debt is less than $2289 (220% of amount in (b), or
d. not working full-time, with low income [less than $2020 (2004)] and monthly income net of student loan payments lower than $1040.80 [amount in (b)].
[Note: (b), (c), and (d) formally require the qualifying income to be below the greater of the HHS Guideline amount or the minimum wage; the HHS Guideline amount now produces a larger amount than the minimum wage.]
2. Unemployment deferment available to borrower who is registered with unemployment agency if within 50-mile radius and has made at least 6 attempts during preceding 6 month period to secure full time work. 34 C.F.R. § 682.210(h)(FFEL); 34 C.F.R. §685.204(b)(2) (Direct); 34 C.F.R. § 674.34(d)(Perkins).
Forbearances:
FFELP 34 C.F.R. § 682.211; Direct Loan: 34 C.F.R. § 685.205; Perkins 34 C.F.R. § 674.33(d) —
a. Generally available where lender believes borrower intends to repay, but is unable to make scheduled payments because of poor health or other acceptable reasons.
b. Loan Debt Burden Forbearance Required where student loan debt burden equals at least 20% of monthly income; limited to total of 3 years. 34 C.F.R. §682.211(h)(2); 34 C.F.R. § 685.205(a)(6).
c. Military mobilization or national emergency: Required where Education Department determines that military mobilization or national emergency affects borrower.
NON-JUDICIAL WAGE GARNISHMENT
When push comes to shove: Non-judicial wage garnishment: Repayment options & financial hardship objections to garnishment Federal law now authorizes guarantors and the Department to collect defaulted loans they hold by non-judicial, “administrative” wage garnishment. Defaulters who do not come to repayment terms with the guarantor (for FFELP loans) or the Department (for any loan held by the Department) ultimately face enforcement by wage garnishment.
• Section 488A of the HEA, 20 U.S.C. § 1095a authorizes both guarantors and the Department to garnish up to 10 percent of the disposable pay of the debtor by an administrative order, without need for a judgment. Federal regulations require guarantors to use this tool, which is now the primary means of enforcing defaulted FFELP loans. 34 C.F.R. 682.410(b)(9). (Perkins schools do not have this authority.)
• The Debt Collection Improvement Act of 1996 enacted 31 U.S.C. § 3720D, a virtual clone of this HEA garnishment authority, which authorizes Federal agencies, such as Education, to garnish up to 15 percent of disposable pay. Education adopted regulations for this authority, 34 C. C.F.R. Part 34, 68 FR 8141 (2003), and has recently started relying on this new authority.
Both the HEA and DCIA require that the debtor be given notice of any proposed garnishment action, an opportunity to avoid garnishment by repaying voluntarily, and a hearing, on request, to dispute both the existence and amount of the debt, and whether withholding at the full rate authorized (10 percent under the HEA; 15 percent under the DCIA) would cause financial hardship. These rights are spelled out in the notices sent prior to garnishment.
Guarantors are free to use any method of evaluating hardship claims; some may use an ad hoc, financial statement-based approach; others, and the Department itself, use a method based on the standards adopted by the IRS for offers in compromise under IRC § 7122(c)(2). 2 The Department encourages, but does not require, guarantors to use this method.
Under this standards approach, a debtor who claims that garnishment at the full 10 or 15 percent rate of his or her disposable pay would cause financial hardship to him or her and his dependents must document the debtor’s household expenses and income. The garnishment order reaches only the debtor’s wages, but whether garnishment of the debtor’s wages will cause financial hardship to the debtor and his or her dependents requires consideration of both the household income as a whole, as well as the household expenses. The debtor’s expenses are then compared by the guarantor or Department with the amounts identified in the IRS standards as the average amounts spent for those same expenses by families of the same size and similar income as the debtor’s. Using data from census and other empiric sources, the standards determine average housing expenses on a county-by-county basis; transportation expenses, on a regional basis; and personal expenses, on a national asis. A debtor who claims to need to spend more for a particular kind of expense than the average amount spent by families in his or her cohort of the standards bears the burden of persuasion that the added amount is necessary.
The Department uses the standards method in garnishment proceedings both to determine the terms of voluntary repayment agreements and the amount to be withheld when agreement cannot be reached:
Repayment agreements:
• For those debtors who respond to a garnishment notice by seeking to repay voluntarily and do not claim hardship, the Department generally is willing to accept – without documentation of expenses – an installment payment arrangement under which the debtor agrees to repay in installment amounts equal to amount collectible at the full garnishment rate authorized (now, 15% of disposable pay). Current pay stubs are sufficient to establish the amount of disposable pay of the debtor. The repayment terms are subject to reevaluation periodically.
• For those debtors who respond to a garnishment notice by claiming hardship but indicate a willingness to repay voluntarily, the Department is willing to accept – upon documentation of income and expenses – an installment payment amount based on available income after necessary household expenses, measured against the standards, are met. If no amount appears available after expenses are met, the Department suspends attempts to garnish. Any repayment agreement or suspension of enforcement action is subject to reevaluation periodically, typically at six six-month intervals.
• Education and the guarantors that employ this method use it only to measure the reasonableness of expense claims, and not to determine the amount of debt that the individual will be required to repay to satisfy his or her obligation.
Amount to be withheld by garnishment order:
For those debtors who object to garnishment on hardship grounds but do not agree to repay voluntarily, the Department uses the standards in the hearing process to evaluate the hardship claim. Based on that evaluation, the hearing official may order withholding at less than the full amount authorized by statute, or may determine that withholding in any amount will cause hardship, and decide that no garnishment should occur. Again, a partial or complete hardship determination is subject to reevaluation periodically; if Education later determines that the financial circumstances no longer show that repayment would cause hardship, the Department will resume enforcement action, starting with a new notice of proposed garnishment, and an additional opportunity to object to that demand.
