Defaulting on a federal student loan may lead to several negative consequences.
Soaring Costs of Collections
Total amount owed will continue to increase due to interest capitalizing as well as collection fees once it is handed off to a collection company. Fees can be up to 18.5% of the principal of the loan for Direct Loans and Federal Family Education Loans. Defaulted Perkins and Health & Human Services loans may exceed 18.5%.
Credit Rating Takes a Hit
Student loan defaults are reported to the Credit Agencies so this can affect your credit score which in turn affects the amount of money you can borrow and/or the interest rate at which you can borrow. At stake are mortgage loans, auto loans, credit cards as well as many other types of loans.
In recent years, some insurance companies have begun including credit history in determining eligibility and rates. Defaulted student loans can cause you to have higher car insurance rates or possibly make it difficult to get car insurance.
Some jobs require credit checks to be done on prospective employees. A student loan default could hinder your opportunity to get that dream job. No job makes paying your student loan even more difficult.
If you do have a job, you may feel like it is already stretched to the limit. If you default on your student loans, the Department of Education or the guaranty agency may require your employer to deduct or “garnish” your paycheck. The Administrative Wage Garnishment (AWG) program is used as a last resort for borrowers who refuse to voluntarily pay their defaulted student loan. For details on the AWG program, borrower rights and how to avoid garnishment, visit MYEDDEBT.ed.gov.
Smaller Income Tax Refund
If you normally receive a refund after filing taxes, a defaulted student loan could change that. In addition to garnishing your wages, your federal income tax refund can be garnished to be applied to pay on your loan.
Federal student loans are one of the few debts that are very difficult to get discharged in bankruptcy proceedings. According to the American Bankruptcy Law Journal, Volume 86, “Congress requires debtors to file an adversary proceeding... proving that repaying their student loans would constitute ‘undue hardship’” So you have to sue the educational lender during the bankruptcy in order to get the student loans discharged. In addition to the cost of filing for bankruptcy, you have the cost of a second lawsuit specifically for the student loans.
Can I Afford to Default?
You have to ask yourself “Can I afford to default on my student loan?” There are several repayment options available to borrowers before defaulting. And if you have defaulted on your student loan(s) , consider “rehabilitating” the loan(s) so that you will be eligible for other repayment options and/or other federal student aid to return to school.