What Happens if You Default on Your Student Loan?

• They Did Not Receive Benefits Promised by Higher Education
• They Struggled to Access Affordable Payments
• Its Severe Consequences Further Eroded Their Financial Security
• How to Exit Loan Default
• New America's Recommendations to Reform the Default System

Student loan debt is one of the biggest financial crises in the U.S. And as education becomes more expensive, more and more people are calling for loans to be forgiven.

But what happens when you can't pay your loans?

During the summer, New America gathered 47 student loan borrowers from across the country who had defaulted on their loans before the COVID-19 pandemic. They were put into focus groups to discover why they had defaulted and how it affected their lives.

According to Credit Karma, a loan default occurs when a borrower fails to make one or more payments for a certain amount of time.

New America found three key findings among the 47 borrowers they surveyed:

• Before borrowers entered default, they did not receive benefits promised by higher education.
• Many participants did not receive a degree or credential.
• Some attended schools that didn't pay off.
• People of color (POC), particularly Black borrowers, are more likely to default even if they have a degree.
• Before borrowers entered default, they struggled to access affordable payments amid financial insecurity.
• Participants missed payments due to financial insecurity.
• When borrowers entered the default system, its severe consequences further eroded their financial security.

'They Did Not Receive the Benefits Promised by Higher Education'

What Happens if You Never Earn a Degree?

According to New America, student borrowers who did not complete a degree program are more likely to default — 12 of the 47 (26%) student borrowers fell into this category. Though these borrowers commonly held less than $10,000 in debt, they lacked the financial returns from a college degree.

"[I had taken out] $5,000 or $10,000 … 30 years ago and I'm still paying on that …" said a participant. "I know [my debt] is not astronomical, but I didn't get the degree out of it either."

Lack of school accommodation threaded these borrowers together. Lack of general accommodation, difficulty transferring credits, and remedial classes frustrated them.

Many of these students had to leave school because of illness or out-of-their-control situations. One student was in and out of college over 15 years due to health issues, and others cycled in and out without ever completing a degree.

"It's the constant circle of 'couldn't finish, still have to pay back the loan,'" said one borrower. "You need to go back to school to get a skill [but you] can't go back to school because you can't afford it and can't get a loan because you have this one."

What if School Doesn't Pay Off?

According to New America, research shows roughly half of for-profit school borrowers default on their loans. Several participants said that their schools either closed or lost accreditation. And some said they were misled by the quality of their schools.

"I'm regretful that I took the loans, because I went to ITT and that school closed … it was a joke …" said one participant. "I got straight A's in one semester, and I didn't even turn in the workbook of the assignments at the end of the year."

People of Color Are More Likely to Experience Default Even With a Degree

Many students of color, particularly Black student borrowers, are more likely to default after graduation than white students. These students often experience discrimination in the job market and must work harder to make similar salaries to white graduates.

"You get a degree and it's not worth what you think it is … so now you're having to go back to school again, to get another degree on top … " said a participant. "You're in a constant quicksand of just reaching for something higher."

According to research found by New America, POC, especially Black students, are more likely to have fewer resources for college, to be targeted by for-profit schools, and to have more debt than white students after college.

'They Struggled to Access Affordable Payments Amid Financial Insecurity'

According to New America, some borrowers get behind on their payments because they must choose between repayment or living essentials.

One borrower lost his car and apartment and had to move back in with his mother. Another had pregnancy complications and couldn't work.

"I was making consistent payments," said one borrower. "And of course my car broke down … and I need my car to work or take my kids to sports. So you've got to choose, 'Do I fix my car or do I pick my payments?' No one's going to pick paying their [student loan] payments over fixing their car."

According to a July 2022 New America brief analyzing data on student loan default, 67% of borrowers defaulted because they couldn't afford to pay, and 71% said they defaulted because they had other debt to take care of first.

'Its Severe Consequences Further Eroded Their Financial Security'

Defaulting Can Spiral Economically Insecure Families Into Poverty

"The default process was clawing back money from the same low-income families that government safety net programs were simultaneously working to lift out of poverty," according to the New America report.

What can happen when a family enters default? According to New America:

A Borrower's Wages, Federal Tax Refunds, and Benefits Can Be Withheld.

Defaulting can limit benefits including the child tax credit, earned income tax credit, and Social Security. New America said that some participants felt crushed that they couldn't save money for their children, and others felt underprepared for any unexpected expenses.

I wasn't expecting it, and I have kids," said one borrower to New America. "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."

They Face High Collection Fees.

One participant said their fees were just as high as the payments themselves, and that they weren't actually paying toward the loan, just the fees.

Half of borrowers who default experience 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.

Their Credit Scores Can Be Damaged.

This was the most prevalent consequence from loan defaults. Damaged credit scores limit quality-of-life purchases like housing and transportation, and, in some states, limit job prospects.

"The credit score damage is the worst," said one borrower. "It affects every aspect of adulthood. Home ownership has been difficult because of my student loans, even though I'm repaying them."

Borrowers Are No Longer Eligible for Federal Financial Aid to Return to School.

New America's July 2022 brief analyzing data on student loan default reported that about a third of borrowers in default could not gain more financial aid for school. The participants felt that this barrier locks them out from 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."

• Borrowers lose benefits and protections they had pre-default, such as IDR (income-driven repayment) plans and payment pauses.
• Borrowers' professional licenses can be suspended or canceled in certain states.
• The loan balance grows because interest continues to accrue, which is not common for defaulting on other loans.

How to Exit Loan Default

There are five ways to exit default, according to New America:

• 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. These 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.

New America found that many participants didn't know how to exit default while others didn't know whether they were currently in default.

"It's gotten to the point where I don't even know if I'm in default," one borrower said. "My loans aren't even hitting my credit score, so it's kind of like I don't know what's happening anymore."

New America found that the norm was for borrowers to find out about forgiveness and discharge programs through friends, family, and self-research. As a result, there was not a clear path to finding these programs such as President Joe Biden's loan forgiveness program, currently blocked by lawsuits.

New America's Recommendations to Reform the Default System

How to Get Borrowers Out of Default

• Establish a fast, flexible pathway out of default that can be used multiple times.
• Raise awareness about cancellation and loan forgiveness and discharge programs.
• Expand access to and automatic uptake of forgiveness and discharge programs.
• Provide additional loan discharges for those spending lengthy times in default, in repayment, or for those eligible for government benefits over time.

How to Protect Borrowers' Financial Security

• Ensure borrowers never pay more in default than they would in their repayments and under an IDR plan.
• Count time in default toward IDR and Public Service Loan Forgiveness.
• Remove defaults from the credit history of all borrowers who exit default (not just those who went through rehabilitation).
• Help borrowers manage growing balances in default by removing accrued interest.
• Create a statute of limitations on collections.
• Increase bankruptcy protections for borrowers.
• Ban credit checks on employment and the suspension or cancellation of professional licenses (only applicable in some states).