What Happens When You Default on a Student Loan?
The consequences of defaulting on federal student loans are very serious. The U.S. Department of Education has very strong powers to compel repayment of private student loans. Borrowers should never choose to default on their federal student loans, as the consequences of default are usually more expensive than switching into an income-driven repayment plan.
The federal government can garnish up to 15\% of a defaulted borrower’s wages, intercept federal and state income tax refunds and state lottery winnings and offset up to 15\% of Social Security disability and retirement benefit payments to repay defaulted student loans. The federal government does not need to get a court order to do this, as the law allows them to do this administratively.
Collection costs will be deducted from the loan payments before the remainder is applied to interest and principal. Not only is this an added cost, but it will also slow the repayment trajectory of the loan, taking several years longer to repay the debt at the original monthly payment amount. Note that the collection charges are based on average collection costs, not actual costs. On federal student loans, as much as 20\% of each payment will be deducted for collection charges. (On private student loans and Federal Perkins loans, collection charges of 25\% to 40\% may be added to the loan balance.)
The federal government will also ruin your credit, by reporting the delinquency and defaults on your credit history to the three major credit bureaus. Your credit score will plummet. This can prevent you from qualifying for other debt, such as credit cards, auto loans and mortgages. Defaulting on a federal student loan may make you ineligible for a FHA or VA mortgage. The drop in your credit score may cause the interest rates on your current loans to increase. Bad credit may affect your ability to rent an apartment, as some landlords check your credit.
A student loan default can affect your ability to get a job in the financial services industry or a job in the military or a job that requires a security clearance. Borrowers who are in default on their federal student loans cannot enlist in the U.S. Armed Forces. The federal government can also prevent renewal of professional licenses, such as for doctors, nurses, dentists and other therapists, teachers, insurance, social workers, accountants, attorneys and veterinarians. In some states, defaulting on a federal student loan may cause your driver’s license to be suspended.
You will be ineligible for further federal student aid after you default on a federal student loan. You will lose eligibility for deferments and forbearances on your federal student loans.
Payment in full on your student loans may be due immediately, including the entire principal balance and any unpaid interest. Note that interest continues to accrue after a loan goes into default. Borrowers who have been in default for decades have reported seeing their loan balance increase to several times the original loan balance.
Your defaulted student loans will be assigned to a debt collection agency, who will start contacting you to demand repayment. You can also be sued. The U.S. Department of Justice will sue you if you owe more than $45,000 and have been delinquent for more than 4 years. If you owe less, you may be sued by private attorneys on behalf of the federal government. These private attorneys work on contingency for up to a third of the amount recovered. If the court issues a judgment against you, it can lead to increased wage garnishment (increasing the percentage from 15\% to 25\%), bank levies, asset seizures and liens against real estate or other property. (A lien prevents sale of the property without satisfying the lien first.)
When you default on a private student loan, the lender will need to sue you to get a wage garnishment order and to seize assets. But, they can report the delinquencies and default on your credit history. Your cosigner will be required to start making payments on the loan.