Federal student loans

How to deal with federal student loans

As total student loan debt in the United States approaches $1 trillion, many borrowers are going into default. On federal student loans alone, the number of people who went into default during the first three years after graduation was a staggering 13.4 percent. There are a few things borrowers can do to deal with runaway student loans.

If the federal student loan is not in default

If a federal student loan is not in default, there are numerous repayment options available, including a number of income-driven payment options. Each of these programs allow a borrower to pay a percentage of his income to his loans (sometimes as low as zero percent) and the remaining debt is forgiven after a number of years (20-25). The government has a web site that allows you to explore these options.

If the federal student loan is in default

Once default occurs, income-driven repayment plans aren't available anymore and the student lender will tack on a 25 percent collection fee to the balance. The lender can then garnish wages and seize tax returns. If a loan is in default, you have two options: rehabilitation or consolidation.


In our experience, rehab is the best option for most borrowers. To rehabilitate your federal loans, you must make nine consecutive reasonable and affordable payments. The payment amounts are determined by your disposable income and can be as low as $5 per month. To start the rehab process, contact your loan servicer and request info on rehab. The servicer is required by law to give you this information. You will likely have to submit some form of income verification.

Once you’ve made the required payments, your loan will be taken out of default status and income-based repayment options are available again. The default status will be removed from your credit report, although past late payments can still be reported.

You can begin the rehab process even if your wages are being garnished or tax refunds are being seized, though the garnishment or seizure probably won’t stop until you’ve made all the rehab payments.

It’s also important to understand that you can only rehab a defaulted loan one time. So it’s critical to transition to an income-driven repayment option once you’ve completed the rehab so you don’t default again.


Consolidation is the process of paying off your defaulted federal student loans with a new loan. Consolidation may be an attractive option for a person who can’t wait nine months to get out of default. Typically, this is someone who wants to go back to school right away and needs immediate access to additional federal student aid that isn’t available when loans are in default. Most, but not all, federal loans are eligible for consolidation.

Before you can consolidate your loans you must either: (1) make three consecutive fully monthly payments; or (2) agree to pay off the new consolidated loan through an income-driven repayment plan.

You can begin the consolidation process by requesting info from your servicer or apply for a consolidation loan directly through the federal government. Consolidation isn’t available if your wages are being garnished, unless you can get the garnishment order lifted.

After consolidation, past late payments and past default status will remain on your credit report.

Finally, consolidation is generally only available one time—you typically cannot consolidate a loan that has already been consolidated.

Discharging federal student loans outside bankruptcy

A federal loan can be administratively discharged by the U.S. Government for a few reasons. These include things like the borrower becomes totally disabled or the school closes while the borrower is attending. More information about these options is available on the federal student loan website.

Discharging federal student loans in bankruptcy

Contrary to popular belief, student loans can be discharged in bankruptcy, but it's not always easy. A student loan can be discharged if paying it would cause "undue hardship" to the borrower. It's not totally clear what this means, since different courts have interpreted this in different ways, but it's definitely something more than just not being able to afford to pay off loan on a borrower's current income. A borrower generally has to show that she will never be able to pay off the loan to have it wiped out in bankruptcy.

Payment plans in Chapter 13 bankruptcy

One last option for borrowers struggling to pay private loans is Chapter 13 bankruptcy. In Chapter 13, a borrower can force the lender to enter a repayment plan over a five-year period.  This can be necessary where a borrower is being sued and the lender is demanding the full amount to be paid at once "or else." The downside to this approach is that if the court-ordered payments are low enough, interest will accumulate faster than it's paid off and the borrower will owe more at the end of the five years.

Differences between federal and private student loans

Probably the first step in figuring out your options for dealing with student loans is to determine whether your loans are federal loans or private loans. Here are the key features of each:


Federal student loans are made or guaranteed by the Department of Education. The most common federal student loan types are Stafford, Direct Loan, PLUS, and Perkins loans. Borrowers can use the National Student Loan Data System to figure out what type of federal loans they have.

Federal student loans generally have lower interest rates and the law gives borrowers many more options for dealing with them if the payments become too burdensome. However, there are very few defenses available if the government begins legal action after default.

Federal student loans are difficult, though not impossible, to wipe out in bankruptcy.


Private student loans are typically made by banks, credit unions, state agencies, or schools themselves. They may have names like “alternative” or “institutional” loans.

Private student loans typically have higher interest rates than federal loans and the borrower’s credit history will often determine the precise terms. And unlike federal loans, borrowers have very few options if they fall behind on payments. On the bright side, borrowers may have more defenses available if a private student loan lender begins legal proceedings.

Although still challenging to discharge in bankruptcy, private student loans may be a little easier to wipe out than federal loans.

How to know if your student loan is in "default"

A federal student loan is in default if you have gone more than 270 days (9 months) without making a required payment. Once a federal loan is in default, a 25% collection fee will be added to the balance and the government may seek to garnish your wages or seize your federal tax refund.

Private student loan default is governed by the loan agreement and may begin after just one missed payment. Private loan contracts also typically provide for default if the borrower: (1) breaks any promise in the loan agreement; (2) files bankruptcy; or (3) makes a false statement in the loan application.

Once a private loan is in default, the loan may be referred to a debt collector or the borrower may get sued by a collection law firm.