What Happens if I Don’t Pay My Student Loans?
Credit: Image Credit: Robyn Beck / AFP / Getty Images- The Trump administration announced it will resume collections on defaulted student loans on May 5.
- A loan default happens after you have not paid back your student loans for some time. The amount of time and how many payments you can miss without penalty depends on the student loan you have.
- If you default on a loan, you may lose tax benefits, wages, and financial aid eligibility. Your credit score may drop, and you could be charged high loan collection fees.
- The Department of Education says a borrower should never pay a company to help them out of student loan default.
Student loan debt is one of the biggest financial crises in the U.S., and after a years-long pause starting in March 2020, the Trump Administration is restarting loan collection on May 5.
According to the Department of Education (ED), there are 42.7 million citizens in over $1.6 trillion of student loan debt. There could be almost 10 million borrowers — 25% of the entire student loan portfolio — in default over the next few months. Defaulting on your student loans can result in tax benefit and wage loss, financial aid ineligibility, high collection fees, and credit scores tanking.
“Resuming collections protects taxpayers from shouldering the cost of federal student loans that borrowers willingly undertook to finance their postsecondary education,” ED wrote on April 21. “This initiative will be paired with a comprehensive communications and outreach campaign to ensure borrowers understand how to return to repayment or get out of default.”
So what exactly happens if you don’t pay back your loans?
What Happens When I Don’t Pay Loans?
According to Credit Karma, a loan default occurs when a borrower fails to make one or more payments for a certain amount of time.
According to the Department of Education (ED), as soon as someone misses the first payment on a student loan, the loan becomes past due, or delinquent. A loan is out of delinquency once the borrower pays it. If the borrower fails to pay within 90 days, the loan servicer reports to the three major credit bureaus (sometimes called consumer reporting agencies). Continued delinquency can result in default.
ED says the timeframe for when a loan goes from delinquency to default depends on the loan. William D. Ford Federal Direct Loan Program or the Federal Family Education Loan Program loans, for example, will default after a borrower fails to make a payment for at least 270 days.
Federal Perkins Loan Program loans servicers, on the other hand, can declare loan default after just one missed payment.
ED recommends borrowers contact the organization that notified them of the default as soon as possible to explain their situation and organize a way out of default.
What Happens if I’m in Student Loan Default?
Over the next two weeks, ED said it will alert borrowers that they’re in default and that collections will begin May 5 if they don’t make a monthly payment, enroll in an income-driven repayment plan, or sign up for loan rehabilitation.
This summer, ED said it will start garnishing borrowers’ wages.
Your Wages, Federal Tax Refunds, and Benefits Can Be Withheld
If a borrower defaults on the loan, the entire balance becomes immediately due. ED says that once this happens, the loan holder can begin collecting on your loan by taking money from your wages or from federal payments like tax refunds.
Defaulting can limit benefits including the child tax credit, earned income tax credit, and Social Security.
“I wasn’t expecting it, and I have kids,” one borrower who had their tax refund withheld told New America in a 2022 survey of 47 student loan borrowers from across the country who had defaulted on their loans before the COVID-19 pandemic. “That big chunk that you get every year [in tax refunds] is a big help to take care of your household. And when I had $5,000 or $6,000 taken away from me … it hurt.”
The borrower continued, “At that point you don’t have the option of whether you’re going to pay it this month or if something is more pressing, you need something at the house, or your car breaks down or whatever, it doesn’t matter. They’re taking it, regardless.”
You Can Face High Collection Fees
According to ED, collection fees are expenses on federal student loans that are added to the outstanding balance of the loan.
One borrower told New America those fees were the amount of the payments. So the payments weren’t going toward the actual loan, just the fees.
Half of borrowers who default are charged collection fees, and over 80% said they felt that those fees damage their finances, according to the July 2022 New America brief analyzing data on student loan default.
Your Credit Score Can Be Damaged
This was the most prevalent consequence from loan defaults. Damaged credit scores can limit quality-of-life purchases like homes and vehicles, and, in some states, limit job prospects.
“The credit score damage is the worst,” said one borrower to New America. “It affects every aspect of adulthood. Home ownership has been difficult because of my student loans, even though I’m repaying them.”
You Might Not Be Eligible for Federal Financial Aid to Return to School
New America reported that about a third of borrowers in default could not gain more financial aid for school. Its focus group participants felt this barrier locks them out of gaining an education to escape financial struggle.
“I wanted to get a college degree. I wanted to become a sociologist …” said one borrower. “So, when I wound up in default, it was basically the end of that dream. While I was in default … I couldn’t return to school and finish my degree that I was so close to getting because I wasn’t able to receive further financial aid or loans at the time.”
Other Consequences of Loan Default
- Borrowers lose benefits and protections they had pre-default, such as income-driven repayment (IDR) plans and payment pauses.
- Borrowers’ professional licenses can be suspended or canceled in certain states.
- The student loan balance grows because interest continues to accrue, which is not common for defaulting on other types of loans.
How Do I Get Out of Student Loan Default?
According to New America, there are five ways to exit default:
- Full loan payoff: Paying all loan-associated fees all at once or over time — either voluntarily or involuntarily through garnishments (wage withholding).
- Rehabilitation: An agreement where a borrower has 10 months to make nine payments as low as $5 a month. This can typically only be used once and can remove default from a borrower’s credit history.
- Consolidation: Borrowers can consolidate all loans into one new good-standing loan and enroll in an IDR payment plan or make three payments. It can typically only be used once and does not remove a default from the credit history.
- Settlement agreements: A rare agreement where borrowers can negotiate to close out a loan.
- Discharge or cancellation: Borrowers can either have their loans discharged or canceled.
ED said it will launch a new enhanced Income-Driven Repayment (IDR) process, which eliminates the need to recertify your income every year.
In an IDR payment plan, your monthly payment is based on your income and family size. The payment plan can last 20-25 years with any remaining balance being forgiven at the end of that period.
However, an IDR plan will likely result in more interest over time if your payments are lower. You may also be required to pay income tax on any forgiven debt if you have any remaining balance.
Do NOT pay for help with a defaulted loan: ED says the Default Resolution Group can help borrowers exit default for free. Borrowers should never work with a company asking to pay enrollment, subscription, or maintenance fees to help them out of default.