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.
Dear Opening Credits,
I have a student loan that defaulted. I was paying and, to date, have paid $11,000 back. My wages were garnished and, all totaled, the payback was about $11,000 on an $18,000 loan originally. To date, the credit company says that I owe them $22,000. I have tried to negotiate with the credit collection company to no avail. Last year, I lost my job because the company I worked for closed its doors. Now, the collection agency said it can garnish my unemployment benefits by 25 percent. If they do that, I will be on the street. I did see your Web page about states and federal government not being able to garnish each other’s debts, but I just wanted to make sure that was the case. I did file for hardship to help get through this tough time. I told the collector that I could pay and expect to pay my debt when I get a job and that I could pay $50 a per month now if they would take my loan out of default. But they said they wanted $175 per month and started with the garnishment talk again. Debt advisers do not handle these cases because it is a federal loan. I would like the right advice on this subject. I saw the home page and was hopeful to get the right answers. I appreciate your website and would really appreciate some right answers. Thank you very much. — M Akay
Dear M Akay,
If your student loans are federally guaranteed — as most are — recognize that they’re a unique type of loan product. Keep them in good standing, and they’re exceptionally great: You don’t need a good and established credit history to qualify; interest rates are tiny compared to other loan types (between 3.4 percent and 5 percent); and the repayment terms are long, with flexible plans available. If you need some breathing room, you can suspend payments and avoid credit damage with deferments or forbearances.
These loans may also grow in importance in coming years, thanks to the Credit CARD Act. This landmark credit card legislation keeps people under 21 years of age from obtaining a credit card unless they can show proof of income or a parent or guardian co-signs with them. That has made more students more reliant on student loans.
The problem is that if you default on student loans, they become pretty awful. Collection activity may be brutal, with high fees being added to the balance, no lawsuit or court order needed for a wage garnishment and tax refunds automatically intercepted to pay for the debt. A notice of default remains on a credit report until cleared, and there is no statute of limitations for collections. Further, they are almost never dischargeable in bankruptcy.
Because your loans are in default, you’ve been experiencing the “awful” end of the spectrum — so let’s get you back to the “great.”
First, know that unemployment benefits are usually exempt from wage garnishment for federally guaranteed student loans, despite what the collector said. Of course, when you do resume employment, the garnishment will probably begin again, and if the collector chooses to sue you for the balance, then yes — depending on the state you live in — 25 percent of your new net wages may be siphoned off to go toward debt.
You said you tried to negotiate to no avail. I believe it. The collectors don’t have to accept anything less than the total balance due because they can pursue you pretty much forever. This puts them in a pretty powerful position.
Now it’s time to reclaim your own power. As per the Higher Education Act, borrowers in default have the right to cure their defaulted student loans by setting up a “reasonable and affordable” payment plan with whoever is holding them. This is a one-time only chance to cure the default by making a total of nine consistent and consecutive payments that are within your means.
Who decides what is in your means? Fortunately, you have considerable say in the decision.The sum is negotiated, with you providing documentation on your income and bills. The collectors cannot set an arbitrary minimum payment. Sure, the collectors would like a regular $175, but if that figure isn’t feasible, you have the right to make your case and make it stick.*
To set this plan up, do the following:
- Review your budget in detail to determine exactly how much you can afford to send each month.
- Contact the collection agency and let them know you understand your legal right to rehabilitate your student loans and that you intend to arrange a “reasonable and affordable” payment plan.
- State your proposed monthly payment. Though they may balk and request that you complete a U.S. Department of Education Financial Disclosure Statement to prove financial hardship.
- Write a letter detailing your offer, and add any supporting documentation. As with all important correspondence, make and keep copies of everything for your records, and send the letter certified mail, return receipt requested.
- When they accept the plan, read their agreement letter carefully before signing.
- Then, start to pay.
Upon completion of nine steady, on-time payments, your loan will be cured and the default notation removed from your credit reports. Don’t assume your credit will be perfect after this, though. It won’t. “The delinquencies that led up to the default will remain for the normal seven years,” says Betsy Mayotte, director of regulatory compliance and privacy for American Student Assistance in Boston.
When the loans are rehabilitated, they’ll be taken out of collections and resold to a lender, and you’ll be placed back on the standard 10-year payment plan. If your payments on the “reasonable and affordable” plan had been tiny, they will increase substantially. However, says Mayotte, you can apply for other more affordable arrangements, such as the income-sensitive plan, which is tailored to your cash flow.
Just make sure, M Akay, that you follow through. This is your one opportunity to get back on track.
* Correction: As originally published, this article stated that setting a “reasonable and affordable” payment amount was at the sole discretion of the debtor. The payment is a negotiated amount that calls on the debtor to document income and expenses. See the CreditCards.com correctitons policy.
See related:Open season ending for credit card marketers on college campuses, A comprehensive guide to the Credit CARD Act, Kids, want help paying off debts? Ask Dad first, 10 ways students can build good credit
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