In 2014, Scott Nailor, a high school English teacher from Scarborough, Maine, went more than 270 days without making a payment on his student loans and so ended up in default. Nailor couldn't keep up with his loan payments while balancing other kinds of debt and providing for his family so, in addition to defaulting, he and his wife filed for bankruptcy.
Nailor had struggled to keep up with his debt since 2000, when he graduated from college owing $35,000. When he stopped making payments over a decade later, his balance had swelled to $55,000, thanks to continually accruing interest.
After he defaulted, Nailor decided that rehabilitating his loans was the best way to get back on track. Federal student loans in default are eligible for rehabilitation, a process that restores loans to good standing after nine monthly payments to a collection agency contracted by the Department of Education.
Student loan rehabilitation programs are one way for borrowers to move forward with repayment after defaulting on federal student loans. But many borrowers don't fully understand the risks, experts say. Since rehabilitation can add a significant amount of money to your balance, the drawbacks can outweigh the benefits and even put borrowers at risk of defaulting again.
Though Nailor successfully completed rehabilitation later in 2014 and has continued to make regular payments, he now owes $130,000 because of the interest and fees for his specific combination of Federal Direct Loans and Federal Family Education Loans.
The debt feels like a problem he'll never be able to solve. "While I'm able to keep my credit from the sewer, there's no way to pay it off," Nailor tells CNBC Make It.
Today, more than 44.5 million people collectively owe $1.5 trillion in student loan debt, according to the Federal Reserve. While the majority of debtors owe between $25,000 and $50,000, about 600,000 people owe more than $200,000.
In 2015, over 10 percent of borrowers in a loan repayment program defaulted within three years, according to recent data from the Department of Education. By 2023, nearly 40 percent of borrowers may default, according to the Brookings Institution. That's thanks to "the low earnings of dropout and for-profit students, who have high rates of default even on relatively small debts," Brookings reports. The fact that tuition has gone up while wages haven't contributes, too.
Defaulting on a student loan damages your credit score, which can affect your ability to secure a credit card, get other loans and buy a house or car. Borrowers in default cannot take out more student loans or pick a repayment plan. The government, through the Department of Labor or the Treasury Offset Program, can also garnish wages, tax refunds and federal benefits to pay off the loan.
Nailor files paperwork every year to stay on a repayment plan that keeps monthly payments manageable and less than what he used to pay. He says he now pays about $530 a month, which does not cover the interest on his loans.
This means that even though he's making payments, his balance continues to grow. The total of $130,000 he now owes is twice his annual salary after 18 years of teaching, and nearly $100,000 more than his initial balance.
"It's kind of like throwing money into a black hole," Nailor says.
Some borrowers choose rehabilitation as a way out of default because after the mandatory payments are completed, the defaulted loan, though not the delinquency, is erased from your credit report.
Rehabilitation might be a decent option for borrowers who would have good credit if not for their student loan default, says Ben Miller, senior director for post-secondary education at the Center for American Progress, but it's a riskier option for others who are in a more economically precarious position.
A third of borrowers who have rehabilitated loans will default again, according to a 2016 Consumer Finance Protection Bureau report. An update to the report in 2017 said that borrowers who were not enrolled in an income-driven repayment plan – which sets monthly student loan payments at an amount intended to be affordable – were five times more likely to default a second time.
This may be due to fees added in rehabilitation, which include the cost of placing the loan with a private collection agency, as well as processing fees and attorney fees from the Department of Justice. These vary depending on the type and age of the loan but can be 15.2 percent to 40 percent.
During rehabilitation, the collection agency works with the borrower to establish a monthly payment that is "reasonable and affordable," says Elaine Rubin, senior contributor and communications specialist at Edvisors.com, a website about college and financial aid. This standard is different from what a lender will use to calculate payments and can mean that borrowers pay less per month than they will have to pay later — which might not help the borrower make progress towards eliminating their debt, especially once fees and interest are tacked on.
"It creates a situation where a borrower is going to be stuck and overwhelmed all over again," says Rubin. Except, the second time they default, borrowers cannot rehabilitate loans again.
"This is a predatory lending system," says Alan Collinge, who runs the activist group Student Loan Justice. "The government over time winds up making a profit on these student loans."
The government is simply putting the penalty of fees on the borrower instead of on taxpayers, says a spokesman for the Department of Education.
"There are many opportunities afforded financially struggling borrowers to avoid defaulting on their loans, including hardship deferments and income-based repayment options that may result in zero dollar payment amounts," he says. "Unfortunately, defaults do still occur."
Even if the borrower does not default again, rehabilitation does not necessarily lessen the hardship of repaying student loans.
Marissa Smith, 22, wanted to get back on track with her student loan debt. She'd received notice that her loans were in default and that she could rehabilitate them.
When she made the last of her scheduled rehabilitation payments, she thought she'd see a reduced balance on her loans. Instead, her initial balance of $10,845 had risen to $15,279.
"I was definitely upset," Smith recalls. "I felt like I had done nine months of getting this into a better system to find out it didn't really help."
Smith took out student loans to study nursing at Westmoreland County Community College in Indiana, Pennsylvania. Like many who default, she left school early without finishing her degree and has struggled to find high-paying jobs.
"It's disheartening, because I really would like to go back to school," Smith says. But, until she has a better handle on her loans, she can't afford to.
One alternative to rehabilitation is to pay the loan in full. For many, "that's a steep proposition," says Miller. Plus, loans paid this way are subject to up to 25 percent interest and fees.
The second option is to consolidate the loan and enter a new repayment plan. This gets the borrower to repayment faster and has lower fees, but does not remove the default from a credit report.
For many borrowers, getting back to repaying the loan and avoiding extra interest and fees is a good idea, says Miller, especially if their credit has suffered from more than just their student loan default. Consistent payments to the new plan will help rebuild credit over time.
These options might change as Congress wrestles with how to address the growing problem of student loan debt.
In December 2017, the House Committee on Education and the Workforce along with the Higher Education and Workforce Development subcommittee announced an update to the Higher Education Act. If it passes, the bill, which is called the Promoting Real Opportunity, Success and Prosperity through Education Reform, or PROSPER, Act, would make it possible for borrowers to rehabilitate defaulted student loans twice.
This could be rough on borrowers who continue to struggle with repayment after rehabilitation, though, as interest and fees would be applied again to their already elevated balance.
The best advice for people taking out loans for higher education is to make sure they fully understand the consequences and how to navigate the system.
The easiest way to avoid default is for borrowers to alert their loan servicer the first time they struggle to make a payment. "Address it as fast as you can," says Rubin. "If you're behind, see if there's anything that can bring you up to date."
A borrower could potentially select a different repayment plan, such as an extended plan or an income-driven repayment plan, Rubin says.
An extended repayment plan fixes the monthly payment for 25 years at a figure generally lower than in a standard plan. It is available for borrowers with over $30,000 in Direct Loans. Income-driven repayment plans calculate monthly payments as a percentage, usually around 10 percent, of discretionary income. Most federal loans and amounts are eligible.
"Income-driven repayment is not perfect, but it is the most immediate fix for borrowers and is probably the place to start," says Miller, as it will keep borrowers from having their wages garnished or tax returns seized.
Other options include deferment or putting the loan in forbearance. Both put loan payments on hold temporarily, but interest might continue to accrue, depending on the type of loan you have. Borrowers should proceed with caution before doing either, Rubin says.
"The borrower is really going to have to make the best decision for themselves," Rubin says. "Make a plan and get yourself prepared for when that monthly payment comes up."
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