More people are defaulting on their student loans — and discovering the consequences are far-reaching.
As many students and parents struggle to make payments on their student loans, many are finding this debt comes with some serious strings attached.
After years of economic difficulty and rising college tuition, the recent news that the default rate on federal student loans has risen came as little surprise to many. Nearly one in ten federal student-loan borrowers defaulted during the two years ended Sept. 30, 2010, meaning they failed to make a payment on their loans for more than 270 days, according to the Department of Education. That’s up from 7% in 2008. Much of that increase came from for-profit colleges, whose students’ default rate jumped to 15% from 11.6%, but the default rate among students at public and private, four-year universities also increased.
What many people may not realize, however, when taking out a student loan is just how different it is from other kinds of debt. Credit-card debt, for example, can be wiped out in bankruptcy. Mortgages can be discharged through foreclosure. For borrowers with crippling student loan debt, financial failure offers no such fresh start. The loan still must be paid off, and often with new collection costs tacked on, making it much more expensive than before. On top of that, up to 25% of a person’s wages can be deducted until the loan is paid back in full. (Private lenders must get court approval for wage garnishment and the amount they can take varies.) With federal loans, the government can also keep your federal and state income tax refunds, intercept future lottery winnings and withhold part of your Social Security payments. "Defaulting can be completely devastating to a family’s finances and sense of well being," says Mark Kantrowitz, publisher of FinAid.org and Fastweb.com.
For borrowers with no other choice but to default, the consequences can be far-reaching. Parents who are cosigners on their kid’s loan may have to divert 401(k) savings to pay off the loans, leaving them in a precarious game of catch-up as they approach retirement. College grads may be unable to buy a home or obtain other credit. As with other types of loans, a student-loan default means a lower credit score. Parents with decent credit could see a decline of up to 200 points, says John Ulzheimer, president of consumer education at SmartCredit.com, a credit-monitoring site. Students’ scores could drop down to the 500s, according to FICO. And unlike mortgage foreclosures, the default can remain on a borrower’s credit score for more than seven years, says Ulzheimer.
To be sure, borrowers who have defaulted can minimize the financial burden by working out a payment plan with the lenders or collection agency. With federal loans, borrowers can also clear a default from their record if they make nine out of 10 consecutive full on-time monthly payments, says Kantrowitz. Borrowers can also try to work out a repayment plan, which can protect them from wage garnishment.
Of course, these plans require that the borrower now has the means to repay the loan even under new terms. That’s a tall order for defaulters, many of whom are recent college graduates that are having a tough time landing a job in this market. The unemployment rate for recent grads age 20 to 24 was 10.7% in August, more than double the rate for those 25 and older who have bachelor’s degree, according to data from the Bureau of Labor Statistics.