Student loan programs, administered by the Federal government and private lenders, have traditionally helped youngsters attend both, graduate and undergraduate school. Federal loans, administered under the Federal Student Aid Programs, are of the following types: Federal Stafford Loans, which are available to students, and Federal Parent PLUS Loans, meant for parents and guardians interested in financing their child’s undergraduate education. Of course, the latter would require the parents/guardians to have a good credit history. Both, Stafford and PLUS loans, can be obtained directly from the government, or from private lender’s whose loans are federally guaranteed. Low interest loans are offered to students by schools participating in the Federal Perkins Loans Program. Sallie Mae, a giant lender in the realm of student loans, was created in 1972 as a government enterprise. It was privatized in the year 2004, and the company provides both, private loans and federally-backed loans. Private banks and non-profit agencies like Student Loan Corp also provide student loans.
Consequences of Student Loan Default
Repaying student loans provided under the Federal Student Aid Programs usually begins 6 to 9 months after a person graduates or drops out of school. In case of ‘The Smart Option Student Loan’, provided by Sallie Mae, the borrower is expected to pay only interest when he is in school, while after graduating he has to make both principal and interest payments.
Lenders have their own repayment schedule, and any delay in making payments can have serious consequences. For instance, in case of Federal loans, which are repaid in installments, default on even a single payment can result in accelerating the repayment schedule for the remaining amount of the loan. The government can take away or ‘garnish’ 15% of a students disposable income as penalty. A portion of social security retirement benefits and disability benefits might also be withheld. Access to other Federal loans may be restricted. Of course, both government and private lenders can sue a person for defaulting, not to mention the impact of such a default on credit scores. A student loan default can remain on record for 7 years. Hence, defaults should be avoided at all costs.
How to Avoid Student Loan Defaults
Alternative Repayment Plans
There are various repayment plans for Federal Loans. A student can consider switching between repayment plans, in case he feels that he is likely to default. Currently there are 4 such plans: Level, Graduated, Income Sensitive, and Extended. The level plan requires a person to pay the same amount of interest and principal during the term of the loan (usually 10 years). In case of graduated plans, a person starts with a lower payment and gradually increases the amount of payment every 2 years. This plan requires a minimum bank balance of USD 2,500. Income-based repayment plans may be appropriate for people with low income, since the amount of repayments cannot exceed 25% of their gross salary. The minimum payment can be as low as 4% of the gross salary. For people who borrowed before October 1998, the extended repayment plan can allow them to extend the term of the loan by 25 years.
Consolidating Federal and Private Student Loans
Consolidating student loans result in reducing the interest rate on several loans by replacing them with one loan that has an extended repayment period, and consequently, a lower rate of interest. Consolidation is an option that can be considered both, before and after default. Federal government allows consolidation of loans in case of Federal Family Education Loans (FFEL) and Direct Loans. In order to qualify for a FFEL consolidation loan, a person needs to make 3 voluntary on-time payments after defaulting on student loans.
Forbearance refers to a situation wherein the borrower is exempted from making payments on student loans for a certain period of time. During this period interest accumulates on the loans. Forbearance on federal loans can be requested in case of poor health, if monthly payments exceed 20% of the borrower’s monthly income, or in case a person is unable to pay the loan within 10 years. Private lenders generally grant forbearance in case of extreme hardships, while non-profit organizations like Student Loan Corp may grant forbearance up to a maximum period of 12 months at no additional costs.
Deferrals on Student Loans
A deferral is similar to forbearance since both result in postponing the repayment of the loan. However, in case of forbearance, interest continues to accumulate, while in case of deferral, interest does not accrue on the loan during the deferral period. Deferrals can be obtained under the following conditions: temporary disability, enrollment in a rehabilitation program, unemployment, receiving public assistance due to economic hardships.
A federal student loan can be canceled in case of permanent disability, military and other uniformed service, or by teaching lower strata of society. Volunteering for Peace Corps may also result in canceling the loan. Sometimes nurses and resident physicians can also get a cancellation on their student loans. Canceling a loan is harder than obtaining a deferral on the loans.
Rising unemployment due to worsening economic conditions has resulted in a number of student loan defaults. In the last 5 years, the cost of obtaining a college degree has increased by 30%. Rising cost of education, coupled with increasing unemployment, has left most students with no option but to drop out of school. The good news for college drop outs is that, returning to school and studying part-time can help them obtain a deferral on most student loans.