Higher Ed

What happens when a borrower defaults on student loans

Defaulting on federal student loans can be as bad as it sounds

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By the end of 2017, almost 9 million people had defaulted on their federal student loans, totaling some $154 billion, according to a report this month from the American Enterprise Institute. And while defaulting — which means not making a payment for at least 270 days — is certainly bad, the conservative think tank wants the public, and in particular the media, to reconsider how defaulting is perceived.

Being in default, the report states, is not a “catastrophic” situation. But, by painting a very grim picture of what happens to borrowers when they default, the report contradicts itself. And many higher education experts describe life in default in nightmare-like terms.

The report makes the case that defaulting is not a permanent status. Among those who default, it states, 7 out of 10 will no longer be in default in five years.

While that may be true, going into default can still have harmful consequences — and those harms are most likely to hit low-income people and other borrowers who may be least able to quickly recover from them.

Related: Federal data shows 3.9 million students dropped out of college with debt in 2015 and 2016

Once borrowers default, it’s reported to credit bureaus and their credit scores take a hit. A low score can make it difficult to rent an apartment, purchase a car or buy a house. And while many borrowers who default will be in good standing within five years, it can take longer than that to fix their credit. As the AEI report notes, a default can remain on a credit report for seven years.

Plus, as the Department of Education says, borrowers who default can have their tax refund withheld, their wages garnished and be taken to court, among other consequences.

The AEI report describes the four ways to return to good standing after defaulting: rehabilitation, which means making a certain number of on-time payments; consolidating loans; paying off loans; or, in rare cases, having the loans discharged.

But, as the group says, only through rehabilitation can defaulting be removed from a credit report.

Meanwhile, defaulting disproportionately affects low-income students and those attending for-profit institutions. As the left-leaning Center for American Progress noted in a December report, “defaulters are more likely to be older, be Pell Grant recipients, and come from underrepresented backgrounds than those who never default.”

The December report also states: “Of the 55 percent of defaulters who resolved their most recently defaulted loans, almost one-half did so by paying off the debt — a solution that could require them to pay large amounts in collection costs.”

The collection costs can indeed be significant, according to a June report from the Brookings Institution. “If the borrower does not make arrangements with their servicer to get out of default, the loan may go to collections. Fees of up to 25% of the balance due may be added as a result,” it says.

The American Enterprise Institute emphasizes that being in default is not a permanent status. It’s less clear, however, if the damage from being in default — possibly losing out on an apartment or being forced to take home a smaller paycheck — will have long-term, or even permanent, effects.

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Delece Smith-Barrow

Delece Smith-Barrow is a senior editor for higher education at The Hechinger Report. She was a 2017 Knight-Wallace Fellow at the University of Michigan, where… See Archive

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