When it comes to the consequences for nonpayment, where you got your loan matters.
Federal loans are issued by the U.S. Department of Education and include Perkins loans and direct loans. Those direct loans may be subsidized, unsubsidized, consolidated or PLUS loans. Private loans, meanwhile, are issued by banks or other lenders, who set the terms for each loan.
Here’s what happens for each of the two types of student loans when you cease your payments:
You stop paying on your federal student loan.
The first day you’re late, your loan’s status moves from “current” to “delinquent.” After 90 days of nonpayment, your lender shares your delinquency with the three major credit bureaus, and your credit score takes a hit. For most federal loans, the government will classify your loan as being in default when you are 270 days late on your loan payment, though Perkins loans may enter default sooner.
Once you’re in default, all bets are off. Instead of owing on your missed payments and the associated penalties, the entire balance of your loan is now due in full. Taunya Kennedy, certified consumer credit and student loan counselor at nonprofit Money Management International, says that the government has broad power over you at this point. “With the government, it could mean the possibility of your wages being garnished. They can also offset your taxes, meaning they can seize your tax return if you are due one. If you are receiving federal funding, they can also seize a portion of those funds.”
In addition, your loan may be sent to a collections agency, which can slam you with massive fees. Or the government might even sue you for the amount you owe. If it wins – and it almost always wins these types of cases – the government is legally entitled to put a lien on assets like your home.
You stop paying on your private student loan.
Think the government response sounds tough? Private lenders are even less tolerant of late payments.
“Private loans can go into default or collections status at right about 120 days of nonpayment,” says Chelsee Spencer, financial wellness expert at GreenPath Financial Wellness, a nonprofit organization. “The lender will have the call on that in terms of when they can send it to collections, so it really can be after just one or two missed payments.”
Defaulting on a private student loan triggers a demand for full payment on the balance of the loan, sends your loan into collections and knocks your credit score down. Debt collectors are limited in the actions they can take to collect from you. Unlike the federal government, private lenders can’t garnish your income without a court order. Consequently, they may take advantage of their only recourse for recovery – hauling you into court.
Did you apply for your loan with a co-signer? Defaulting on your private student loan means you’re taking that person down with you. Both you and your co-signer are on the hook for payments due. If your co-signer has deeper pockets, your lenders may choose to go after that person instead of you. And your co-signer’s creditworthiness could go down the drain right alongside yours.
How Is Your Credit Affected by Nonpayment?
Here’s the good news: Making consistent, on-time payments in the required amounts can be a great way to prove your fiscal responsibility and build your credit score. On the flip side, not keeping up with your repayment responsibilities will tank your score.
For most people, a bad credit score can seriously hamper your ability to live a financially successful life. Lousy credit means you’ll likely struggle to qualify for loans, credit cards and other lines of credit, and you’re stuck with pricier options for the credit lines you can open. Additionally, your credit history may be accessed by utility companies, insurance companies, landlords and employers. In other words, getting that phone plan, car insurance policy, apartment or job might be much harder.
And Kennedy says that, in addition to facing worsening credit, people who experience difficulty in paying their student loans risk slipping into a dangerous debt spiral. “Balances tend to increase over time because of the interest that accrues on your unpaid balance,” she says, “so it can become more of a challenge to pay off a debt.”
What Are Your Options When You’re Struggling to Pay?
Nothing good happens when you simply stop repaying your education loans. Neither Spencer nor Kennedy ever recommend that a borrower just give up on making loan payments. In fact, Spencer’s most important piece of advice is this: Get on the phone and stay in close contact with your loan servicer. “That’s the only way you’re going to know what options are available,” she says.
Both loan counselors note that, once your debt is in default, most of your options go out the window. So you are far better off addressing your inability to pay early on instead of waiting until your loan goes to collections. Depending on your type of loan and your financial circumstances, your options may include the following:
An alternate payment plan
Spencer says that many of the people she counsels aren’t even aware that they have options on how to repay federal loans. The standard plan, in which you’re usually enrolled by default, puts you on a 10-year repayment schedule. But you can easily apply online, at no cost, for a plan with a longer repayment period and with less money due each month.
Heads up: When you extend the term of your loan in order to reduce monthly payments, you voluntarily sign up to pay more interest. If, however, you’re struggling to meet your monthly minimums right now, that trade-off might be worthwhile.
The federal government’s income-driven repayment plans typically extend your repayment period up to 20 or 25 years and forgive any balance remaining after that time is up. Your IDR options may include some of the following plans:
- Revised Pay As You Earn: Available only for direct loans, REPAYE typically calculates your required monthly payments as 10 percent of your average monthly discretionary income.
- Pay As You Earn: PAYE, a program that preceded REPAYE, is similar to REPAYE in most areas. There are some differences, however, in who’s eligible, whether your spouse’s income is considered, how long you must wait for forgiveness eligibility and some other factors.
- Income-Based Repayment: Predating both PAYE and REPAYE, IBR has more stringent limitations on who qualifies for the plan and calculates your monthly payments as high as 15 percent of your average monthly discretionary income. IBR is available for both direct loans and FFEL loans.
- Income-Contingent Repayment: If you’re looking for an income-driven repayment plan for your parent PLUS loan, the ICR is your only option. Under ICR, you could pay up to 20 percent of your average monthly discretionary income toward the loan.
Remember: Signing up for an income-driven repayment plan is an option only if your federal loan has not yet gone into default.
Additionally, keep in mind that you may need these plans only temporarily. Kennedy says that many people are reluctant to choose an alternate payment plan because they think they’ll be stuck with that choice going forward. But these plans can help you get back on track with your debt repayment when you’re facing short-term financial hardship. And you can change your repayment plan at any time at no cost.