This week I received an email from someone seeking advice on how to deal with her defaulted federal student loans. Specifically, she wanted to know if direct loan consolidation was a better option or if it was better to rehabilitate her loans.
When your loans federal student loans are in default, the options are not particularly attractive. Both choices, rehabilitation and consolidation, have downsides. However, both options are far better than letting your federal loans stay in default.
What is the difference?
Rehabilitation and consolidation both accomplish the same goal… getting your federal student loan or loans out of default.
When you rehabilitate your loans, you work with your loan servicers on a monthly payment plan to get your loan current. Rehabiliation requires the borrower to make nine payments in a ten month period to bring the loan out of default. This has to be done for each loan that is in default.
Consolidation requires the borrower to go through federal direct consolidation. Consolidating your loans means that your old loans will be paid off and that you will be left with a new larger consolidated loan.
Which route is fastest?
Loan rehabilitation takes nearly a year and it is necessary for the borrower to work with each lender to bring all of their loans out of default.
Consolidation, by comparison, is a much faster process. Filling out the paperwork can be done very quickly, and it typically takes the department of education people about 30 days to collect all of the necessary information so that all of the loans can get paid off. This process takes approximately 30 days, and once completed your new loan is current and you are no longer in default.
Which is better for my credit score?
This is one area where rehabilitation gets a big edge. By rehabilitating your loans, the notation on your credit report that you went into default will be removed. The late payments will still be on your report, so it doesn’t fix everything, but getting rid of the default is a big plus.
If you consolidate your loans, the fact that you went to default, will remain on your credit score for up to 7 years. As a result, going with the immediate consolidation route, does more damage to your credit report.
What about the fees?
This is one area that hurts regardless of the route that you choose. Consolidation can result in fees up to 18.5% while rehabilitation can result in fees up to 16%. This is one area where it would benefit you to reach out to your lender to see where you can save some money on fees.
When will the collectors go away?
The collectors stop as soon as your loans are consolidated or as soon as you complete the rehabilitation process. Once your loans are brought out of default, you won’t be contacted again as long as you keep your loan current.
How do I stay out of default?
The best part about getting your federal loans out of default is that you can remain on one of the many great federal repayment plans. Income based repayment plans, such as PAYE, ensure that even if you are unemployed, you can keep your loans current and your credit back on track.
For further reader check out:
The Student Loan Borrower Assistance Factsheet
NOLO information on consolidation and rehabilitation