Student loan debt is one of the biggest issues impacting Americans' lives today. As of 2023 Q1, the Federal Reserve Bank of St. Louis reported outstanding student loan debt in the United States totaled $1.77 trillion.
You may be tempted to simply ignore your debt, but this is a very bad idea with serious consequences. In most respects, defaulting on a student loan has exactly the same consequences as failing to pay off a credit card. However, in one key respect, it can be much worse. That is, should the government take action to get what it's owed.
Most student loans are guaranteed by the federal government, and the feds have powers about which debt collectors can only dream.
Please note: President Biden announced a new income-driven repayment (IDR) plan on June 30, 2023. It offers enhanced financial benefits to student loan borrowers. Three important features launched during the summer of 2023, while the full regulations take effect on July 1, 2024. Read on to learn more.
Key Takeaways
- You may be able to use federal student loan assistance programs to help you repay your debt before it goes into default.
- Let your lender know that you may have problems repaying your student loan.
- Failing to pay your student loan within 90 days classifies the debt as delinquent, which means your credit rating will take a hit.
- After 270 days, the student loan is in default and may then be transferred to a collection agency.
- Keeping up with your student loan payments helps improve your credit score.
First, You’re Considered Delinquent
When your loan payment is 90 days overdue, it is officially delinquent. That fact is reported to all three major credit bureaus. Your credit rating will take a hit.
That means any new applications for credit may be denied or given only at the higher interest rates available to risky borrowers.A bad credit rating can follow you in other ways. Potential employers often check the credit ratings of applicants and can use them as a measure of your character.
Cellphone service providers also check credit ratings. They may deny you the service contract you want. Utility companies may demand a security deposit from customers they don’t consider creditworthy. A prospective landlord might reject your application.
The Supreme Court ruled on June 30, 2023 that the Biden administration lacked the authority to cancel up to $20,000 of federal student debt per borrower. This put an end to the student loan forgiveness that President Biden originally announced back in Aug. 2022, which had been in legal limbo since Nov. 11, 2022.
The three-year forbearance on student loan payments and interest that began back in 2020 ended this year. Student loans began accruing interest on Sept. 1, while required payments restarted in October.
The Account Is in Default
When your payment is 270 days late, it is officially in default. The financial institution to which you owe the money refers your account to a collection agency. The agency will do its best to make you pay, short of actions that are prohibited by the Fair Debt Collection Practices Act (FDCPA). Debt collectors also may tack on fees to cover the cost of collecting the money.
It may be years down the road before the federal government gets involved, but when it does, its powers are considerable. It can seize your tax refund and apply it to your outstanding debt. It can garnish your paycheck, meaning it will contact your employer and arrange for a portion of your salary to be sent directly to the government.
What You Can Do
These dire consequences can be avoided, but you need to act before your loan is in default. Several federal programs are designed to help, and they are open to all who have federal student loans, such as Stafford or Grad PLUS loans, although not to parents who borrowed for their children.
Three similar programs, called Income-Based Repayment (IBR), Pay As You Earn (PAYE), and Saving on a Valuable Education (SAVE), reduce loan payments to an affordable level based on the applicant’s income and family size. The government may even contribute part of the interest on the loan and will forgive any remaining debt after you make your payments over a period of years.
The balance is indeed forgiven, but only after 20 to 25 years of payments. The payments may be reduced to zero, but only while the indebted person has a very low income.
The Public Service Loan Forgiveness Programis designed specifically for people who work in public service jobs, either for the government or a nonprofit organization. People who participate may be eligible for federal debt forgiveness after 10 years on the job and 10 years of payments.
Details of these federal programs are available online,as is information about eligibility.It is important to remember that none of these programs are available to people whose student loans have gone into default.
A good first step is to contact your lender as soon as you realize you may have trouble keeping up with your payments. The lender may be able to work with you on a more doable repayment plan or steer you toward one of the federal programs.
The New SAVE Program
On June 30, 2023, President Biden announced a new income-driven repayment (IDR) plan called SAVE. It offers student loan borrowers new and improved benefits, such as forgiving a student loan with an original principal amount of $12,000 or less after 10 years of payment (rather than the previous 20 to 25 years).
SAVE will replace the existing REPAYE plan. Those already enrolled in REPAYE will be enrolled in SAVE automatically. The full slate of SAVE regulations goes into effect on July 1, 2024. However, during the summer of 2023, three significant features went live:
- The amount of a borrower’s income protected from payments will rise to 225% of the federal poverty guidelines from 150%. So, a single borrower earning less than $32,805 annually ($67,500 for family of four) will have no payments. Those loan holders who don’t meet this threshold will save at least $1,000 per year.
- Interest charges not covered by a borrower’s monthly payments will be halted so that no unpaid interest can increase the amount a borrower owes.
- Married borrowers who file taxes separately won’t have to include a spouse’s income in the calculation of their payment amounts.
For more information about SAVE, see the Department of Education’s fact sheet.
One Upside
There is an upside to student debt.If you keep up your payments, it will improve your credit score. That solid credit history can be crucial for a young adult trying to secure that first car loan or home mortgage.
Worst-Case Scenario
A true worst-case scenario involved a man who found armed U.S. marshals on his doorstep. He had borrowed money 29 years earlier and failed to repay the loan. The government finally sued. According to the U.S. Marshals Service, several attempts to serve him with a court order failed. Contacted by phone in 2012, he refused to appear in court.
A judge issued an arrest warrant for him that year, citing his refusal to appear. When the marshals finally confronted him outside his home, he told CNN, “[I] went inside to get my gun because I didn’t know who these guys were.”
That’s how you end up facing an armed posse of U.S. marshals, with local police as backup, for failure to pay a student loan of $1,500. For the record, the man said he thought he paid the debt, didn’t know about the arrest warrant, and didn't remember the phone call.
However, even this sorry story has a reasonably happy ending. Hauled into court at last, the man agreed to begin paying off his ancient student loan, plus accrued interest, at the rate of $200 a month. After 29 years of interest, the $1,500 debt had grown to around$5,700.
Do Student Loans Go Away After 7 Years?
Typically after seven years, defaulted student loans are removed from your credit report, like all defaulted loans. This primarily applies to private student loans. Note that this isn't a reason to not pay your student loans because you still owe the debt. And if the debt is transferred, it may show up on your credit report again.
Can Unpaid Student Loans Result in Your House Being Taken?
No, unpaid student loans do not result in your property being seized. Student loans are unsecured so they do not have any collateral that can be seized legally. A private lender, such as a bank, would have to sue you and win to be able to seize your assets. For federal loans, your wages can be garnished or your tax refunds withheld.
Do Mortgage Lenders Look at Student Loans?
Yes, they do. When assessing your creditworthiness, mortgage lenders will look at all of your outstanding debt, including student loans.
The Bottom Line
The government and banks have an excellent reason for working with people who are having trouble paying off their student loans. You can be sure that they are as anxious to receive your loan payments as you are to repay your debt.
Just make sure that you alert the appropriate parties as soon as you see potential repayment trouble ahead. Ignoring the problem will only make it worse.
