If you google this topic you will get hundreds of thousands of hits. There are a lot of people who have something to say about this. As usual there is a lot of misinformation floating around, repeated by people who have not looked up the statutes and regulations.
My goal here is basic. I want to help you understand the tools you have to clean up, post-default. I also want to help you understand why ignoring the problem is not a good option.
First, let me explain why you shouldn’t just ignore your federal student loans and wait for them to age off your credit report. Federal student loans are different than other types of debt. Unlike other types of debt that becomes uncollectable after a certain period of time, the statute of limitations does not apply to federal student loans.
Yep, this means that if you are in default and do nothing, that the federal government can sue you 20 years from now. And yes, they do that. Imagine, you are just about to retire, looking forward to some golf and fishing and you are slapped with a Department of Justice lawsuit demanding principle, interest, and collection costs. Yikes! No thank you!
Also, the way your federal student loan default is reported on your credit report is different. The Higher Education Act sets out special rules that apply to federal student loans. The rules vary depending on whether the student loan is a Direct Loan, a FFEL Loan, or a Perkins Loan. Don’t know what you have? You can easily look it up. See my other article “Tips for Managing Your Student Loans and Paying Them Off Faster” for an explanation on how to get information on your loans.
Your Direct or FFEL Loan default can be reported for seven years from the latest of three dates, all of which could be years after the default itself. The first date that initiates the running of the seven-year period is the date the guarantor pays on the defaulted loan. This is, in effect, when the federal guaranty agency takes over the loan. (Federal student loans are backed by the federal government this is why the federal government eventually takes over if you don’t pay, even if your loan was e.g. originally through Sallie Mae.)
The second date that triggers the running of the seven-year period is the date the delinquency was first reported to the credit reporting agency. The third trigger date is if a borrower re-enters repayment but then defaults again. As the seven years runs from the latest of these dates, you can see why the federal default might be on your report much longer than a regular default. Plus, as you face the possibility of a credit damaging judgment 20 years from now, I don’t think the “age off” strategy makes sense.
Also, if you have Perkins Loans, they are not subject to any limit on reporting. Thus, they can stay on your credit report until you pay them in full, even if that is 20 years from now.
Now that I have emphasized that the wildly popular “ignoring my loans and hoping they will go away” is not a good solution, let me highlight some possible remedies.
If you are granted a closed school, false certification, unpaid refund, or defense to repayment discharge you won’t have to repay the loan at issue. In addition, following the discharge all negative account history associated with the loan should be removed from your credit report.
When a discharge is granted, the guarantor or the Department of Education must tell the credit reporting agencies to delete all adverse credit history associated with the loan. Consumers can follow up after discharge by obtaining a copy of their credit report to ensure all adverse information has been deleted. If the negative credit history is still there it can be disputed with the credit reporting agencies and the Department of Education, which should result in its removal.
A successful disability discharge will also improve your credit report by showing the loan as paid in full. However, unlike the above discharges a disability discharge does not remove the account historical information from your report.
Admittedly most students are not eligible for a statutory discharge. But considering the amazing benefits, you should certainly take the time to investigate whether you are or not. See “Student Loan Discharge” on my website for further discussion of the various statutory discharges.
Loan Rehabilitation vs. Loan Consolidation
Loan rehabilitation is another useful tool that provides some but certainly not complete credit report relief. Under the federal loan rehabilitation program, Direct and FFEL borrowers can rehabilitate their loans by making nine consecutive on time payments. Payments will generally be 15% of discretionary income (although you can request a lower payment based on financial hardship). Perkins borrowers must make a full monthly payment for nine consecutive months.
I have seen loan rehabilitation bashed on the internet because it does not necessarily provide an immediate FICO score jump. But let me explain why I think it is one of the better long term options.
First, loan holders are required to remove the record of default after a successful rehabilitation. Does this mean all your credit report problems immediately vanish? No. Loan holders are only legally required to remove the record of default. Default is not a status that credit reporting agencies normally use. Instead, indicators such as the fact that the account was in collection or that a claim has been paid on the account are the indicators of a default. When a loan is rehabilitated, the lender must remove such indicators.
Thus, while other negative history generally stays until it ages off, the fact that the default indicators are removed and that you do not have an account in collections, will have a positive impact over time. While this is not a perfect solution when it comes to cleaning up your credit report, ultimately it comes down to this: Do you have a better option? At least with the rehabilitation program you are removing the record of default and can start back on the road towards freedom from student loans.
A federal direct consolidation is another way to get out of default. Please don’t be confused by all the advertisements. You can only do a federal direct consolidation through the federal government. And it is free. Go to https://studentaid.ed.gov/sa/repay-loans/consolidation for more information.
Unlike rehabilitation, however, a federal direct consolidation does not remove the record of default. Instead it results in a notation that the defaulted loan was paid in full. Your subsequent payment history on the consolidated loan will be reported under a new account. Nothing magical happens here. But your score will gradually improve as you make timely payments on the new account.
Finally, if you were a victim of fraud or forgery or have some other claim or defense with respect to the loans, you can seek removal of both the current and historical information as part of a settlement. Obviously what you can negotiate will depend on your circumstances and the strength of your case. If you believe you fall into this category, you should consult with a student loan attorney.
I hope you found this information helpful. If you need the help of a student loan attorney, you can call me at (904) 419-9858.
Cleaning Up Your Credit Report after a Federal Student Loan Default