Student Loan Rehabilitation
Rehabilitation of defaulted federal student loans requires making a series of consecutive qualifying monthly payments as part of a loan rehabilitation agreement. After a borrower has made three consecutive qualifying payments, the borrower regains eligibility for federal student loan consolidation. After a borrower has made six consecutive qualifying payments, the borrower regains eligibility for federal student aid. After a borrower has made 9 out of 10 consecutive qualifying payments, the default is removed from the borrower’s credit history.
Qualifying payments must be full, reasonable and affordable, voluntary and on time. On-time payments must be made within 15 days of the due date for the borrower to regain eligibility for consolidation loans and federal student aid. For removing the default from the borrower’s credit history, on-time payments must be made within 20 days of the due date.
The rehabilitation rules require qualifying payments to be reasonable and affordable, which will be defined as part of the loan rehabilitation agreement. Initially, the guarantee agency or collection agency will offer a monthly payment equal to 15\% of discretionary income. Discretionary income is the amount by which adjusted gross income (AGI) exceeds 150\% of the poverty line. If you can’t afford that, you can ask to have the payment be based on your documented income and expenses. The monthly payment may be reduced to as little as $5 a month. Collection agencies prefer monthly payments that are more than about 1\% of the outstanding loan balance (ranges from 0.76\% to 1.29\%) because then they earn their full commission on the rehabilitated loan.
Voluntary payments do not include any involuntary payments made through wage garnishment or the offset of income tax refunds. So, the payments made through the rehabilitation agreement will be on top of any involuntary payments. However, sometimes borrowers are able to negotiate a monthly payment that is the greater of the involuntary payment and the voluntary payment amount, if this is at least $5 more than the involuntary monthly payment.
Borrowers can also rehabilitate their defaulted federal student loans through consolidation into the Direct Loan program, if they agree to repay them through an income-based repayment plan (income-contingent repayment for Federal Parent PLUS loan borrowers), as part of a loan rehabilitation agreement. The monthly payment must be at least $5 per month. Collection costs of up to 16\% of the loan balance may be added as part of consolidation, but may be sometimes waived by the U.S. Department of Education (e.g., if the borrower quickly resumes making voluntary monthly loan payments soon after the default). This will stop collection charges from being deducted from the monthly loan payments. This form of rehabilitation restores eligibility for federal student aid quicker than making a number of consecutive on-time payments, but it does not remove the default from the borrower’s credit history.
Rehabilitation represents a one-time opportunity to restore student loans to a current status. If you default again, you will no longer be eligible for rehabilitation. Your only option then will be to pay off the debt in full.