Savanna Hoffman
Student loans are a significant issue for many people, and failure to pay can have serious consequences. While student loans are a form of unsecured debt, meaning that your home or car cannot be seized if you fail to make payments, there are still repercussions for missed payments. These include a drop in your credit score, late fees, wage garnishment, tax refund garnishment, and social security payout/benefit garnishment. Private lenders can also sue you and seize your assets if they win. It is important to reach out to your lender and explore relief options if you are experiencing financial difficulties.
| Characteristics | Values |
|---|---|
| Credit score | Your credit score will take a hit, which may result in higher interest rates, or rejection of credit applications. |
| Late fees | Late payments may incur late payment fees. |
| Wage garnishment | Your wages can be garnished. |
| Tax refund | Your tax refund can be withheld. |
| Social security payouts | Defaulting on federal student loans can result in garnishment of social security payouts/benefits. |
| Interest | Interest will continue to accrue on the loan. |
| Debt collection | The federal government guarantees most student loans and can act as a debt collector. |
| Bankruptcy | Student loans are not automatically discharged in bankruptcy, but federal student loans can sometimes be discharged. |
| Private lenders | Private lenders can sue you and, if they win, seize your assets. |
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What You'll Learn
Your credit score will drop
Student loans can have a significant impact on your credit score, and failing to pay them back can have serious consequences. Here are some key points to consider:
The Impact of Missed Payments
Firstly, it's important to understand that even one missed payment on your student loan can lower your credit score. Late payments can remain on your credit report for up to seven years. This negative information can affect your creditworthiness and may lead to your loan being considered delinquent. According to the Federal Reserve Bank of New York, a new student loan delinquency can cause a credit score drop of more than 150 points.
The Effect of Account Closure
When you pay off a loan and close the related account, it can also negatively impact your credit score. This is because active accounts with a long history of on-time monthly payments help build your credit. By closing the account, you lose this positive payment history. Additionally, closing student loan accounts can negatively affect your credit mix, especially if you only have revolving credit remaining, such as credit card debt.
Building Credit with Student Loans
On the other hand, student loans can help build your credit score when managed responsibly. Making timely payments on your student loans can positively impact your credit score. Student loans can bolster your credit mix, especially if you don't have many open credit lines. Over time, this can increase your average credit age and raise your score.
Strategies to Manage Student Loan Debt
To maintain a healthy credit score, it's crucial to stay on top of your student loan payments. If you're facing financial difficulties, reach out to your lender to explore relief options. You can also consider refinancing your loan to obtain a lower interest rate and more manageable monthly payments. Remember, becoming debt-free is the ultimate goal, and managing your credit responsibly can help you achieve this.
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You may face late fees
If you're facing financial difficulties and are unable to make your monthly payments, your finances could be impacted in multiple ways. Loans are considered delinquent immediately after one missed payment. While your lender or loan servicer might not report you as late to the major credit bureaus until you're 90 days past due, you might face late fees.
Late fees are imposed when payments are not received by the due date, adding to the overall cost of the loan. The late fee could be a percentage of your payment or a flat fee, such as $25 or $5.00. For example, you could be charged up to 6% of your missed payment amount as a late fee. So, if you skip a $300 payment, you could be charged an $18 fee.
If you're unable to pay the late fees, your account may be handed over to a collection agency, and collection costs may be added to your loan balance. Lenders may also take legal action to recover the outstanding amount, resulting in additional legal fees and potential court judgments.
To avoid late fees, it's important to prioritize your loan payments in your budget and consider enrolling in AutoPay to ensure timely payments. If you're facing financial hardships, explore options like deferment or forbearance to temporarily halt payments.
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Your wages could be garnished
If you default on your unsecured student loan, the government or a private lender can garnish your wages. Wage garnishment involves the lender or government automatically deducting a certain amount from your paycheck each month to repay the defaulted loan balance. The federal government can garnish up to 15% of your disposable income without a court's permission if your federal student loans are past due for longer than 270 days.
If you have private student loans, a lender can garnish your wages with a court's permission. A law firm may purchase your debt and garnish your wages, causing financial hardship. To avoid wage garnishment, you can negotiate repayment terms with the U.S. Department of Education or the collection agency assigned to your account. You must make your first payment no later than 30 days from the day the wage garnishment notice was sent. Private lenders may also be willing to negotiate a repayment agreement or loan settlement.
You may request a hearing if you believe that wage garnishment will create extreme financial hardship or if you have been employed for less than 12 months after losing a previous job. If your hearing is successful, your wages won't be garnished for a 12-month period, or you may qualify for a partial garnishment. If your hearing is unsuccessful, your wages will be garnished at 15% of your disposable income.
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You could be sued by the lender
If you default on your unsecured student loan, the lender might sue you. While this is uncommon for federal student loans because the government has other means of collecting the debt outside of court, it is possible and more common with private lenders. If you are sued, you will be served with a copy of the lawsuit in person or via mail. The lender must be able to prove that they own the debt and that it is, in fact, your debt. They will need documents like the original promissory note and proof of the chain of buying and selling the debt.
If you are sued, you should talk to a lawyer right away. You may have defences to the lawsuit, such as if your identity was stolen or if the debt was discharged in bankruptcy. You will need to raise any applicable defences in a formal response to the lawsuit; otherwise, you will likely lose the chance to get out of paying the debt. If you ignore the lawsuit, a default judgment could be entered against you, and the lender could get a lien against your house, seize money from your bank account, and garnish your wages.
Even if you think you owe the debt, you may still have defences. Each state has different laws and rules for debt collection cases, so your rights may depend on where you live. You may be eligible for free help from your local legal aid office or free resources from courts or websites like Lawhelp.org. It is important to note that you usually only have a short amount of time to respond to the lawsuit, so acting quickly is crucial.
Additionally, there is a time limit on private student loan collections. The statute of limitations sets a time frame within which a creditor may sue you, and this varies depending on the state and the contract. For example, in Maine, the time limit is typically six years after the last payment or account activity. Consulting with a lawyer can help you understand if this defence applies in your specific circumstances.
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Your loan could be discharged in bankruptcy
It is a common misconception that student loans cannot be discharged in bankruptcy. While it is challenging, it is not impossible to discharge student loan debt in bankruptcy. Bankruptcy is often seen as a last resort due to its potential negative impact on your credit score and the costs and time involved in filing. However, if you are overwhelmed by debt, consulting an experienced bankruptcy attorney can help you explore this option.
To discharge your student loans in bankruptcy, you must demonstrate "undue hardship." This typically involves showing that you cannot repay your loans and meet your basic needs, indicating a cycle of poverty. The court will decide whether you meet the criteria for undue hardship, and if so, the judge can either discharge your loans entirely or partially or modify the loan terms to make repayment more manageable.
The type of bankruptcy case you file will also influence the outcome. For example, in a Chapter 7 bankruptcy, you request the judge to cancel all your debt, but you must have an income below a specific threshold to qualify. On the other hand, a Chapter 13 bankruptcy involves reorganizing and reducing your debt without an income requirement. However, you must adhere to a repayment plan set by the bankruptcy court for 3 to 5 years before the remaining debts are cancelled.
It is important to note that discharging student loans in bankruptcy requires additional steps, such as filing a petition for an adversary proceeding. This process can be complex, and it is advisable to seek legal guidance to ensure you understand your rights and options.
While bankruptcy can provide a fresh start for those struggling with student loan debt, it is not the only option. Before considering bankruptcy, explore alternative forms of relief, such as income-driven repayment plans, forbearance, or loan consolidation. Additionally, if you are experiencing financial hardship, reach out to your lender to discuss possible solutions. They may be able to provide temporary relief or assist you in exploring other options to manage your debt.
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Frequently asked questions
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. Your wages can also be garnished, or your tax refunds withheld.
A delinquent loan is one that has missed a payment. Loans are considered delinquent immediately after one missed payment, but your lender or loan servicer might not report you as late to the major credit bureaus until you’re 90 days past due.
A default loan is when your payment is 270 days late. At this point, the loan is officially in default and may be transferred to a collection agency.
If you’re experiencing financial difficulty, it’s worth reaching out to your lender to explore forms of relief that may be available to you. You may be able to use federal student loan assistance programs to help you repay your debt before it goes into default.
