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What Happens When You Stop Paying Your Student Loans

US News & World Report -  Money logo US News & World Report - Money 7/9/2018 Megan Nye
170914_StudentLaptop: Both deferment and forbearance offer temporary solutions for contending with student loans.© (Getty Images) Both deferment and forbearance offer temporary solutions for contending with student loans.

In a perfect world, you'd have no student loan debt. And, if you did, you wouldn't have taken on more debt than you could handle. Or you wouldn't be facing financial setbacks that are making repayment of those loans a daunting task.

But the fact remains that, in 2017, the average student loan balance sat at $34,144 – a record high for the nation. And, on average, more than 3,000 people default on their federal loans every day, according to government data.

So you're not alone if you're struggling to keep up with burdensome student loan payments. And it's understandable why you might be tempted to stick your head in the sand and quit repaying altogether. But is that strategy really your best bet?

What Happens When You Stop Paying Your Student Loans?

When it comes to the consequences for nonpayment, where you got your loan matters.

Federal loans are issued by the U.S. Department of Education and include Perkins loans and direct loans. Those direct loans may be subsidized, unsubsidized, consolidated or PLUS loans. Private loans, meanwhile, are issued by banks or other lenders, who set the terms for each loan.

Here's what happens for each of the two types of student loans when you cease your payments:

You stop paying on your federal student loan.

The first day you're late, your loan's status moves from "current" to "delinquent." After 90 days of nonpayment, your lender shares your delinquency with the three major credit bureaus, and your credit score takes a hit. For most federal loans, the government will classify your loan as being in default when you are 270 days late on your loan payment, though Perkins loans may enter default sooner.

[Read: The Best Student Loan Consolidation Lenders of 2018.]

Once you're in default, all bets are off. Instead of owing on your missed payments and the associated penalties, the entire balance of your loan is now due in full. Taunya Kennedy, certified consumer credit and student loan counselor at nonprofit Money Management International, says that the government has broad power over you at this point. "With the government, it could mean the possibility of your wages being garnished. They can also offset your taxes, meaning they can seize your tax return if you are due one. If you are receiving federal funding, they can also seize a portion of those funds."

In addition, your loan may be sent to a collections agency, which can slam you with massive fees. Or the government might even sue you for the amount you owe. If it wins – and it almost always wins these types of cases – the government is legally entitled to put a lien on assets like your home.

You stop paying on your private student loan.

Think the government response sounds tough? Private lenders are even less tolerant of late payments.

"Private loans can go into default or collections status at right about 120 days of nonpayment," says Chelsee Spencer, financial wellness expert at GreenPath Financial Wellness, a nonprofit organization. "The lender will have the call on that in terms of when they can send it to collections, so it really can be after just one or two missed payments."

Defaulting on a private student loan triggers a demand for full payment on the balance of the loan, sends your loan into collections and knocks your credit score down. Debt collectors are limited in the actions they can take to collect from you. Unlike the federal government, private lenders can't garnish your income without a court order. Consequently, they may take advantage of their only recourse for recovery – hauling you into court.

Did you apply for your loan with a co-signer? Defaulting on your private student loan means you're taking that person down with you. Both you and your co-signer are on the hook for payments due. If your co-signer has deeper pockets, your lenders may choose to go after that person instead of you. And your co-signer's creditworthiness could go down the drain right alongside yours.

How Is Your Credit Affected by Nonpayment?

Here's the good news: Making consistent, on-time payments in the required amounts can be a great way to prove your fiscal responsibility and build your credit score. On the flip side, not keeping up with your repayment responsibilities will tank your score.

[Read: The Best Private Student Loans of 2018.]

For most people, a bad credit score can seriously hamper your ability to live a financially successful life. Lousy credit means you'll likely struggle to qualify for loans, credit cards and other lines of credit, and you're stuck with pricier options for the credit lines you can open. Additionally, your credit history may be accessed by utility companies, insurance companies, landlords and employers. In other words, getting that phone plan, car insurance policy, apartment or job might be much harder.

And Kennedy says that, in addition to facing worsening credit, people who experience difficulty in paying their student loans risk slipping into a dangerous debt spiral. "Balances tend to increase over time because of the interest that accrues on your unpaid balance," she says, "so it can become more of a challenge to pay off a debt."

What Are Your Options When You're Struggling to Pay?

Nothing good happens when you simply stop repaying your education loans. Neither Spencer nor Kennedy ever recommend that a borrower just give up on making loan payments. In fact, Spencer's most important piece of advice is this: Get on the phone and stay in close contact with your loan servicer. "That's the only way you're going to know what options are available," she says.

Both loan counselors note that, once your debt is in default, most of your options go out the window. So you are far better off addressing your inability to pay early on instead of waiting until your loan goes to collections. Depending on your type of loan and your financial circumstances, your options may include the following:

An alternate payment plan

Spencer says that many of the people she counsels aren't even aware that they have options on how to repay federal loans. The standard plan, in which you're usually enrolled by default, puts you on a 10-year repayment schedule. But you can easily apply online, at no cost, for a plan with a longer repayment period and with less money due each month.

Heads up: When you extend the term of your loan in order to reduce monthly payments, you voluntarily sign up to pay more interest. If, however, you're struggling to meet your monthly minimums right now, that trade-off might be worthwhile.

The federal government's income-driven repayment plans typically extend your repayment period up to 20 or 25 years and forgive any balance remaining after that time is up. Your IDR options may include some of the following plans:

  • Revised Pay As You Earn: Available only for direct loans, REPAYE typically calculates your required monthly payments as 10 percent of your average monthly discretionary income.
  • Pay As You Earn: PAYE, a program that preceded REPAYE, is similar to REPAYE in most areas. There are some differences, however, in who's eligible, whether your spouse's income is considered, how long you must wait for forgiveness eligibility and some other factors.
  • Income-Based Repayment: Predating both PAYE and REPAYE, IBR has more stringent limitations on who qualifies for the plan and calculates your monthly payments as high as 15 percent of your average monthly discretionary income. IBR is available for both direct loans and FFEL loans.
  • Income-Contingent Repayment: If you're looking for an income-driven repayment plan for your parent PLUS loan, the ICR is your only option. Under ICR, you could pay up to 20 percent of your average monthly discretionary income toward the loan.

Remember: Signing up for an income-driven repayment plan is an option only if your federal loan has not yet gone into default.

Additionally, keep in mind that you may need these plans only temporarily. Kennedy says that many people are reluctant to choose an alternate payment plan because they think they'll be stuck with that choice going forward. But these plans can help you get back on track with your debt repayment when you're facing short-term financial hardship. And you can change your repayment plan at any time at no cost.

Loan consolidation

If the task of managing multiple payments is what's tripping you up, simplifying your loans might be a way to get control.

For your federal loans, see if you qualify for a direct consolidation loan, which transforms your multiple federal loans into a single loan with a fixed interest rate that's based on the average interest rates of your existing loans. There's no cost to apply for a direct consolidation loan.

For your private loans, review your options with the institution servicing your loan. If your credit score has improved significantly since you applied for your student loans, you may find that you qualify for a lower interest rate on the consolidated loan than you did for your individual student loans.

[Read: Getting Student Loans Without a Co-Signer.]

Deferment or forbearance

Both deferment and forbearance offer temporary solutions for contending with student loans. Specifically, they significantly decrease or eliminate your monthly student loan payments for up to 12 months. While deferment and forbearance are generally only available through federal student loans, some private lenders may offer similar programs.

What's the difference between deferment and forbearance? Loans in forbearance continue to accrue interest during the forbearance period. That amount will be added to your total loan balance, or you can pay the interest off as you go. Many loans in deferment, however, absolve you of paying interest during the deferment period, so your loan balance doesn't increase during that time.

Loan forgiveness

The Public Service Loan Forgiveness program forgives the balance of your direct loans after 10 years of good payment. To qualify for PSLF forgiveness, you must be employed full-time by a specific government or nonprofit entity. You may also qualify for loan forgiveness if you're a full-time volunteer with AmeriCorps or Peace Corps or are a veteran with service-related disabilities.

If your loan forgiveness is the result of reaching the end of your income-driven repayment plan term, there may be a catch. Since the federal government is effectively "giving you" the money by forgiving your loan, you may need to pay ordinary income tax on the amount forgiven. Depending on how much that is, you could be looking at a huge out-of-pocket tax bill for the year of your forgiveness.

However, the PSLF program doesn't saddle you with a tax bill when granting loan forgiveness.

Personalized help

If dealing with your loans or lenders feels like too much for you, consider talking with an accredited nonprofit credit counselor. And call before you're in over your head. "A lot of times, people who contact us for the student loan counseling are already in default or are behind," says Spencer.

Kennedy says that a knowledgeable counselor can assist you in taking a holistic approach to your finances – looking not just at your student loan payments, but also at your income and all of your expenses. Then, together you can devise an overall approach to managing your finances and creating a strategy for getting on top of your student loan debt.

Is Bankruptcy an Option?

Bankruptcy should be your absolute last resort. The process will cost you attorney's fees and many months of effort. And a bankruptcy will remain on your credit history for up to 10 years.

Plus, there are no guarantees in bankruptcy. If you file for Chapter 7 bankruptcy, a court might discharge your remaining student loan debt. But only about 40 percent of bankruptcy applicants who seek to have their student loans discharged are actually successful.

And student loan experts almost never recommend pursuing a bankruptcy claim. "It's not common to see bankruptcy as a solution for student loan debt," says Kennedy.

Spencer adds that declaring bankruptcy is an uphill battle in that you have to prove long-term, undue hardship and demonstrate a good-faith effort to repay your loans.

If you're struggling to pay your student loans, start looking into your options now. Kennedy says, "Student loan debt is nothing to be ashamed of." As a student loan counselor, she strongly encourages borrowers not to suffer in silence. Stopping payment altogether usually makes a difficult situation even worse, so get proactive and reach out for the help you need early on.

Copyright 2017 U.S. News & World Report

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