3 ways to rebuild your credit after wage garnishment

Opening Credits columnist Eric Sandberg
Erica Sandberg is a prominent personal finance authority and author of "Expecting Money: The Essential Financial Plan for New and Growing Families." She writes "Opening Credits," a weekly reader Q&A column about issues for people who are new to credit, for CreditCards.com.

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Question for the CreditCards.com expert

Dear Opening Credits,
For the past two years, I have been making payments on defaulted student loans. This payment was in the form of wage garnishment. Each payment was to the amount of 15 percent of my income. Over the past two years, I have been able to pay over $12,000 against the loans. And with the wage garnishment, I haven't missed a payment. My credit report still lists the original loans as "potentially negative closed."

My questions are as follows: 1. Will my loans ever return to good standing with consecutive payments? (For example, be resold to a loan lender and new repayment terms established.) 2. How can I start to rebuild my credit after this hard time? 3. Will the credit report ever label the loans as "good standing with payments"? Thank you. -- Sherry

Answer for the CreditCards.com expert

Dear Sherry,
There should be a new TV reality show called "When student loans go bad," or perhaps, "Student loan rehab." Unfortunately, it seems you could star in both.

Federally granted student loans always start off great, with low interest rates and favorable terms. Keep them in good standing and life is grand. Allow them to descend into default, however, and the plot thickens.

The damage to your credit report began with your first missed payment, but your credit score really took a nosedive when the loan defaulted. Having the big "D" on a credit report is terribly damaging. Even more dramatic is that wage garnishment you're dealing with. I'm not sure if you were also sued, since the Debt Collection Improvement Act allows holders of defaulted loans to dip into a paycheck without a court order. They have the right to withhold up to 15 percent of your net wages until the debt is satisfied.

You may think that your credit report would see some improvement after two years of paying that way, yet while the payments have eroded some of the balance, they've done nothing for your history or score. The reason is that, officially, you are still in default.

For clarification, I spoke with Deanne Loonin, a staff attorney with the National Consumer Law Center (NCLC) and director of the Center's Student Loan Borrower Assistance Project. "Payments made via a wage garnishment aren't considered voluntary," says Loonin, "and therefore are not reflected on your credit report positively." To establish a normal, positive payment pattern, you'll first need to rehabilitate your payments.

So how do you rehabilitate your loans? By contacting the holder and arranging a "reasonable and affordable payment" plan. It's your one and only opportunity to cure the defaulted loan by making nine consecutive payments of whatever you can afford. After that, the default is lifted -- yes, gone from the reports!

Because of the garnishment, though, your situation is a little trickier. Here are your three ways to work around it, says Loonin, starting with the best possible scenario:

  1. Ask that the garnishment be lifted and that you be allowed to arrange the reasonable and affordable plan instead. No dice? On to the next possibility...
  2. Request that a portion of the amount you are currently paying through the garnishment be considered the reasonable and affordable plan. If that is denied, you have one final option...
  3. Make extra payments on top of the garnishment, which will be considered the reasonable and affordable plan. Take heart that the loan holder can't deny this proposal, but it may be a bit of a financial hardship for you.

Once you finish the series of payments, you will be out of default and eligible for all the excellent payment options available to those with loans in good standing, including consolidation.

There is one problem with rehabilitation, and it can be an expensive one: 18.5 percent of the remaining balance will be added to what you owe.

If you need guidance or assistance during this process, contact the NCLC's Student Loan Borrower Assistance Project or the Department of Education's Ombudsman.

As you're working your way through rehab, I recommend using credit cards to simultaneously build your credit rating. Charge regularly, and pay in full and on time. By doing so, you'll be proving your new borrowing proficiency. Such positive activity can offset previous damage.

Finally, Sherry, make a commitment to remain financially responsible. I'm sure the last thing you want to do is take the lead in any more unsavory reality programs.

See related:  Don't worry if resold student loan clutters up your credit report, Key things to know about credit reports and scores, How wage garnishment works and how to avoid it, Cure your defaulted student loan in six steps

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Updated: 03-21-2019