Defaulting student loan borrowers get an overhaul

About 7.5 million student borrowers with loans in default are set to get a fresh start – a chance to enter repayment in “good standing” – but only if they agree.

Borrowers have up to one year after the payment pause in progress expires – currently scheduled for August 31, but is expected to be extended – to enroll in the “Fresh Start” program and arrange payments, according to the Department of Education. During that year, they will not face collection costs or other punitive consequences of default, such as wage garnishment. But if they don’t act before the end of the one-year limit, their loans will remain in default.

The program was announced on April 17 as part of the sixth extension of the federal student loan payment pause that began in March 2020. But it took four months for details to emerge.

Student loans are past due when they are 30 days past due, and they default when the borrower has not made a payment for 270 days. Once this happens, federal aid to the school is halted and collection efforts begin, including garnishing wages or seizing tax refunds. The damage to credit history is extensive: nine months of late payments, plus one default, make it harder for borrowers to qualify for credit cards, mortgages or car loans. Federal loans are not easily discharged in bankruptcy courts, and there is no statute of limitations for collection efforts.

Who should look for a fresh start?

The Fresh Start program addresses most consequences of default by removing penalties and making the rehabilitation process inexpensive and easy. The problem? You may need to make payments in the future.

The program won’t be automatic, but there’s no downside, says Betsy Mayotte, president and founder of the Institute of Student Loan Counselors.

“For those who say ‘I can’t afford it’, you may be able to if there is no default because you will have access to lower payment options,” explains Mayotte. “You will potentially be able to seek forgiveness through existing forgiveness options.”

Income-Based Reimbursement, for example, reduces payments to a portion of your income and extends your repayment to 20 or 25 years, after which the remaining balance is paid off. Payouts under these plans could be as low as $0.

“Federal student loans don’t have a statute of limitations, so it makes sense to get yourself out of default and into a payment plan that — even if you don’t pay it back in 20 or 25 years — has a discount at the end of that,” says Mayotte. “Whereas, if you remain in default, there is no automatic forgiveness.”

For borrowers looking to enroll in this time-limited program, here’s what we know and don’t know.

Only federal student loan borrowers will get a fresh start

The Fresh Start program will apply only to borrowers with federal student loans, which include direct loans, Perkins loans and federal loans for family education held by the government and held by individuals.

According to data provided in March by the Department of Education, about 7.5 million federal student loan borrowers have loans in default.

Defaulted loans that will not be eligible for Fresh Start include:

  • Perkins loans held by the school.

  • Loans from the Health Education Assistance Loan Program.

  • Loans under the jurisdiction of the United States Department of Justice.

  • Direct loans and FFEL loans held by companies that are in default after the end of the student loan payment pause and the pause on collections.

Borrowers will have to say “yes”

Borrowers with eligible student loans should contact the Department of Education’s Default Resolution Group or their loan holders to enroll in the program and arrange for long-term payments.

Once borrowers have made payment arrangements, their loans will be transferred to a new loan manager who does not handle delinquent loans.

It is unclear how long this process will take or how quickly borrowers will be reimbursed after signing up.

To make payment arrangements under the Fresh Start initiative, borrowers can:

  • Contact their individual loan holder.

  • Call the default resolution group at 800-621-3115.

You will not have to consolidate, rehabilitate or offer a cash lump sum to emerge from default under the initiative. All you have to do is register and pay the agreed monthly amount.

Borrowers can access repayment options and discount again

Borrowers whose loans are in default and come into good standing will be able to access the full range of loan repayment and forgiveness options available.

This means that borrowers will be able to enroll in a graduated repayment plan, an extended repayment plan, or an income-based repayment. They can also work to cancel public service loans if their new payments are eligible.

A fresh start for credit reports too

Under Fresh Start, when borrowers make payment arrangements and have their loans transferred to a new servicer, they will also see the default removed from their credit report.

Loans that are more than seven years past due will be removed from borrowers’ credit reports. It will also be easier to obtain new loans for defaulting borrowers; the “default” flag will be removed from the system used by lenders to verify an applicant’s information.

Borrowers can access their credit reports for free at AnnualCreditReport.com.

Borrowers can get new loans to get a degree

Borrowers in default are generally less likely to have obtained a degree. Under Fresh Start, schools are advised to provide access to federal aid, which includes federal student loans, to defaulting borrowers. This is available to all borrowers with loans in default, even if they are not applying for Fresh Start relief.

“Those who drop out have a much higher risk of default than those who get their degree or title, and default prevents them from completing that degree — it’s a kind of Catch-22,” says Mayotte. “Hopefully this will help them complete their education so they can afford to pay off their student loans.”

Collection activities will not restart for a year

Borrowers who do not take advantage of the Fresh Start initiative will not see collections activity until one year after the end of the payment pause. This means that your wages will not be garnished or your tax refunds will not be garnished and you will not have to face collection costs.

After a year of initiative, the Department of Education expects collections to resume.

About Kristina McManus

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