After years of rising college tuition and decreasing middle class income, the news that the default rate on federal student loans has increased is little surprise. According to the Department of Education, nearly one in ten federal student-loan borrowers defaulted during a two-year period that ended on Sept. 30, 2010. “Defaulted” means the person responsible for the repayment of the loan failed to make a payment for more than 270 days. While much of that increase was attributed to for-profit colleges, where the default rate jumped to 15% from 11.6%, the default rate among students at public and private four-year universities also increased.
As students and parents struggle to make the payments for their student loans, many are finding this type of debt comes with strings attached. Taking out a student loan is different from other kinds of debt and the loans are nearly impossible to discharge. Financial failure and bankruptcy offers no fresh start as the loan still must be paid off and will often have new collection costs tacked on, making the loan more expensive.
Private lenders can get court approval for wage garnishment for up to 25% of a person’s wages until the loan is paid back in full. If the loan is a federal loan, the government can keep your federal and state income tax refunds, intercept future lottery winnings and withhold part of your Social Security payments in addition to garnishing your wages. Parents who are cosigners on their child’s student loan may have to divert 401(k) savings to pay towards the loans, leaving them to catch-up as they approach retirement.
A student-loan default means a lower credit score. Parents with good credit could see a decline of up to 200 points and students’ scores could drop down to the 500s. The default can remain on a borrower’s credit score for more than seven years. After a student loan default, college graduates may be unable to buy a home or obtain other credit.
Borrowers who have defaulted can minimize the financial burden of a default by arranging a payment plan with the lenders or collection agency responsible for collecting on the loan. If the loan is a federal loan, borrowers can also clear the default from their record if nine out of 10 consecutive full on-time monthly payments are made. A repayment plan may be worked out to protect yourself from wage garnishment.