- Federal vs. Private
- Federal Student Loan Repayment Plans
- Forgiveness and Cancellation
- How can I avoid defaulting on my student loans?
- Collection Lawsuits
Federal vs. Private
First, let’s take a look at the different kinds of student loans available. The federal government funds many student loans. There are three main types of federal student loans: Direct Loans, Direct PLUS Loans, and Federal Perkins Loans. You can apply for any federal student loan with the Free Application for Federal Student Aid (FAFSA).
Direct loans may be subsidized or unsubsidized. Direct Subsidized Loans are available to undergraduate students who demonstrate financial need and your school determines the amount you can borrow. The government will pay your interest on a Direct Subsidized Loan while you’re in school at least half time, for the first six months after you graduate (the grace period), and during your deferment if you have one. Direct Unsubsidized Loans are available to any student regardless of need and your school will determine the amount you can borrow. You can choose to pay the interest while you’re in school or the entire amount of interest you accrue during school and any grace periods or deferments can be added to the principal amount of your loan after graduation. Interest rates on Direct Loans for undergraduates are 3.86% if your loan is disbursed between July 2013 and July 2014 and 4.66% if your loan is disbursed between July 2014 and July 2015. For graduate students, the rates are 5.41% and 6.21%, respectively. You’ll also have to pay a disbursement fee of about 1% of the value of the loan.
PLUS Loans are available only to graduate or professional degree students. To take out a PLUS Loan, you must pay a disbursement fee of around 4%. You’ll have to start repaying the loan as soon as it is fully disbursed. PLUS Loans have no grace period, but you may be able to defer.
Federal Perkins Loans are available to students with serious financial need. Schools are the lenders for Perkins Loans and not all schools participate in the program. The interest rate is 5%. Perkins Loans have a 9-month grace period after you graduate, drop out, or start attending classes less than half-time. You won’t have to start repayment until the end of the grace period.
Before 2010, the Federal Family Education Loan (FFEL) program allowed private lenders to make loans backed by the federal government. The program was discontinued through the Health Care and Education Reconciliation Act of 2010, so the FFEL program is no longer available.
If federal student loans aren’t enough, you can also take out private student loans. Private student loans are just like any other loan, except, just like federal loans, they cannot be discharged in bankruptcy. Private student loans generally carry a higher interest rate than federal loans, may not have a grace period or deferment option after graduation, and may require you to pay interest throughout your studies. The terms of private student loans vary widely, so shop around for the best deal and make sure you have a clear understanding of what you’re signing up for.
Private loans may have a grace period. If so, you’ll start making payments after the grace period. If not, you’ll start making payments as soon as you graduate. Private student loans are just like any other loan – you’ll pay a certain amount each month. The amount will depend on the amount of your loan and the interest rate.
For any federal loans other than PLUS loans, you won’t have to start repayment until after the grace period has expired. Direct Loans and FFEL Loans have a grace period of 6 months. Generally, interest will accrue to your account during the grace period. Perkins Loans have a 9-month grace period. The grace period starts when you graduate, drop out, or start taking classes less than half-time. Your grace period may be extended if you restart school, are called to active military duty, or consolidate your loan during the grace period. You can repay federal student loans just like private student loans with a flat monthly payment. However, you can also use any of several repayment plans.
Federal Student Loan Repayment Plans
With standard repayment, you’ll pay the least possible interest over the course of your loan. You’ll have a maximum of 10 years to repay the loan and your monthly payments will be at least $50. Making a flat monthly fee may be very difficult for new graduates, so you can choose from six repayment plans if you won’t be able to make standard payments. You can change your repayment plan at any time. Generally, these alternative repayment plans are available for all loans except PLUS loans made to parents. If you’re choosing between repayment plans, you can use this tool to estimate your payments.
– Graduated Repayment
A graduated repayment plan lasts for 10 years just like standard repayment. However, your payments will start small and increase every 2 years. You’ll pay more interest than you would with flat monthly payments, but this plan may be easier if you’re expecting to start with a low salary and earn more as time goes on.
You can also repay a Direct Consolidated Loan with a graduated repayment plan, in which case the plan may last for up to 30 years.
– Extended Repayment
If you have over $30,000 in Direct Loans or FFEL Loans, you may use an extended repayment plan. You can’t use the extended plan for any other type of loan less than $30,000. For example, if you have $40,000 of Direct Loans and $22,000 in FFEL Loans, you can only use the extended plan for the Direct Loans. An extended plan lasts for up to 25 years and you can choose to make flat payments or gradually increasing payments. You’ll pay more interest than you would under either a standard repayment plan or a graduated repayment plan, but your monthly payments will be lower than under those plans.
– Income-Based Repayment (IBR)
You must have a “partial financial hardship” to take advantage of IBR. You have a partial financial hardship if your standard monthly payments would be higher than your IBR payments. Payments under IBR are 15% of your discretionary income, which is the difference between your monthly income and 150% of the state poverty line and the plan lasts for 25 years. As of the date of publication, one hundred fifty percent of the California state poverty line is $1,458 per month for a single person, $1,966 for a household of 2, and $2,981 for a family of 4. So, if you make $2,000 per month and you’re single with no dependents, your IBR payment would be about $81 (15% of $2,000 – $1,458).
IBR comes with several benefits besides the lower monthly payment. First, your payments will change from year to year so if your family grows or you earn less, the payments will adjust to take account of the changes. If your payments aren’t enough to cover the interest that’s accruing on your loan, the government will pay that interest for up to three years. In addition, accrued interest won’t be added to the principal amount of your loan (capitalization), so you won’t end up paying interest on your interest. If you haven’t paid off your loan after 25 years, the remainder of the loan is forgiven. Finally, if you pay on time for 10 years while working full-time for a public service organization, the balance of your loan will be forgiven after those 10 years.
– Pay As You Earn Repayment
Like IBR, the Pay As You Earn plan requires that students have a partial financial hardship – standard monthly payments must be higher than they would be under Pay As You Earn. In order to qualify for Pay As You Earn, the plan must result in greater total payments than a 10-year standard repayment plan. Pay As You Earn lasts for 20 years, after which the remainder of your loan will be forgiven.
Your payments will be 10% of the difference between your income and 150% of the state poverty line. As mentioned above, as of the date of publication 150% of the state poverty line in California is $1,458 per month for a single person, $1,966 for a household of 2, and $2,981 for a family of 4.
As with IBR, the government will pay any interest that your plan payment doesn’t cover for up to 3 years. Interest will not capitalize unless you no longer have a partial financial hardship. In any case, at most interest equal to 10% of your original principal will capitalize. As in IBR, your loan balance will be forgiven if you work in public service for 10 years and make full, on-time payments the entire time.
– Income-Contingent Repayment (ICR)
The Income-Contingent Repayment plan adjusts your payments based on your income, family size, and loan amount and you don’t need partial financial hardship to qualify. As with Pay As You Earn, the plan must result in greater total payment than you would make under a standard 10-year repayment plan. The plan lasts for a maximum of 25 years, after which your remaining balance will be forgiven. Your monthly payments will be the lesser of 20% of your discretionary income (calculated the same way as under IBR) and the amount you would pay if you were making standard payments over 12 years, multiplied by an income-based factor that changes annually.
As with Pay As You Earn, this program caps the amount of capitalized interest at 10%. Interest will continue to accrue after the 10% mark, but it won’t be added to your principal balance so you won’t have to pay interest on that interest.
– Income-Sensitive Repayment
This plan requires that you pay more than you would under a standard 10-year repayment plan and has no partial hardship requirement. The plan lasts for 10 years. Your monthly payments will change based on your income; each lender uses a different formula to calculate your payments.
Repayment plans for Perkins loans vary by school, so contact your school’s Financial Aid office to ask about repayment options.
Under certain circumstances, you can “defer,” or put off, paying your federal student loans. The government will pay the interest on your Perkins Loan or Direct Subsidized Loan during deferment, but you’ll have to pay the interest on any other loans. You may defer your loans if you’re enrolled in school at least half-time or during an approved graduate fellowship program. You may defer your loans for any period of active duty military service during a war, military operation, or national emergency and for up to 13 months after the end of your active service if you’re a reservist or were called to active service within 6 months of being enrolled at least half-time. Finally, you can defer your loans for up to three years if you are unemployed, can’t find a full time job, or are suffering economic hardship (such as service in the Peace Corp).
If you don’t qualify for deferment, you may be able to get a forbearance. A forbearance allows you to reduce your payments or stop making payments for up to a year. Lenders generally must give you a forbearance if you are in a medical or dental residency program, your monthly payment is greater than 20% of your monthly income, you are in a national service position and receive a national award http://www.nationalservice.gov/programs , you qualify for teacher loan forgiveness, you qualify for the U.S. Department of Defense Student Loan Repayment Program, or you’re a member of the National Guard who has been activated but does not qualify for deferment. Lenders have the option to grant a forbearance for financial hardship or illness.
Forgiveness and Cancellation
Under some circumstances, you may be forgiven part or all of your student loan.
Sometimes, a student won’t be able to make payments even with the help of a repayment plan. If you fall behind by one or more payments, you’re considered to be delinquent on the account. After 90 days without a payment, your loan servicer will report the delinquency to the three major credit bureaus, which will damage your credit score. A low credit score will make it harder for you to get a credit card, an auto loan, a mortgage loan, an apartment, or a cell phone plan.
After 270 days without payment, you’re considered to be in default. Default is even worse for your credit score than delinquency and has additional serious consequences. When you default, the entire balance of your loan comes due. You become ineligible for deferment, forbearance, and additional federal student aid. The loan servicer will hand your account over to a collection agency, which will have the right to withhold your federal and state income tax refund and sue you for collection. In California, you can be sued for collection up to 6 years after you default. Cal. Com. Code § 3118(a). If you lose a collection lawsuit, the collection agency may get a court order to levy your bank accounts or garnish your wages.
Teacher Loan Forgiveness and Cancellation
Teachers who have passed state tests in the relevant subjects and hold at least a bachelor’s degree and a state teaching license may qualify for Teacher Loan Forgiveness (for Direct Loans) or Teacher Loan Cancellation (for Perkins Loans). Those who teach for five or more consecutive years at a qualified low-income elementary and middle schools are eligible for up to $5,000 in forgiveness of their Direct Loans. High school math and science teachers and special education teachers at qualifying low-income schools are eligible for up to $17,500 in forgiveness of their Direct Loans. Those who teach for at least one full academic year at a low-income school, teach special education, or teach in a subject for which there is a shortage of teachers (as determined by the state) may receive up to 100% discharge of their Perkins Loans, with 15% cancelled in each of the first and second years, 20% in each of the third and fourth years, and 30% cancelled in the fifth year.
Public Service Loan Forgiveness Program (PSLFP)
If you work in public service for 10 years and make full, on-time payments for that duration, the remainder of your loan will be forgiven. You must work full-time at a government agency or a private not-for-profit organization that is tax-exempt under IRC § 501(c)(3). Work for other not-for-profit organizations is acceptable if the organization provides certain public services. You may qualify for the PSLFP if you’re repaying your loan through a standard 10-year repayment plan, IBR, Pay As You Earn, or ICR.
Perkins Loan Cancellation
Aside from Perkins Loan Cancellation for teachers, you can earn cancellation of a percentage of your Perkins Loans each year by working in the Peace Corps, ACTION program, military (in hostile areas), as a nurse, police or corrections officer, Head Start worker, or in child or family services. Other Loan Forgiveness and Cancellation Your Direct and Perkins Loans may be discharged if you acquire a total, permanent disability or if you die. Your Direct Loans may be discharged if your school closes. You may also receive a partial discharge of your Direct Loans if your school has withheld a refund or if your school signed the loans without your authorization or falsely certified that you would be able to pay the loan. Similarly, you are not liable for the loans if they were incurred as a result of identity theft or other fraud.
How can I avoid defaulting on my student loans?
You definitely want to avoid defaulting, but you can’t make your payments. You can’t even discharge your student loans in bankruptcy, barring extreme extenuating circumstances. So what can you do? Thankfully, the federal student loan programs offer a couple of options to help you get back on track.
Federal Student Loan Consolidation
If you’re worried that you can’t make your payments, consider loan consolidation. When you consolidate loans, you turn one or more loans into a single loan with a fixed interest payment and a longer life. Federal consolidated loans can have a term as long as 30 years. Because the term is so long, your monthly payments will be lower. You can also pay under any federal student loan repayment plan.
You may consolidate almost any type of federal student loan. To qualify, at least one of your Direct Loans has to be in a grace period or in repayment. If one of the loans you want to consolidate is already in default, you’ll have to either reach an agreement with your loan servicer or repay the new loan under IBR, Pay As You Earn, or ICR.
Federal Student Loan Rehabilitation
If your loan is already in default, you may use Loan Rehabilitation to bring it back into the clear. A default will show on your credit report but will be removed if you rehabilitate your loan. You’ll work with your loan servicer to decide on a reasonable payment and sign a rehabilitation agreement. Generally, the payments will be 1% of your outstanding balance. You’ll have to make payments on time (within 20 days of the due date) for 9 months. If you make the required payments, your loan servicer will sell the loan to another lender and you’ll be returned to pre-default status.
Once you start rehabilitation, you can’t be sued for collection or have your wages garnished until the end of the process (successful rehabilitation or default). After your loan is successfully rehabilitated, you will one again be eligible for alternative payment plans, deferment, forbearance, and additional federal aid. You may only rehabilitate a loan one time; if you default again you won’t have that option.
If you’re concerned about making the payments on your private student loans, your best option is to reach out to your lender. Explain your situation and ask for other payment options. They may be willing to refinance the loan, lower your interest rate, or extend the term of the loan.
If you’re sued for collection and lose, the court will enter a judgment against you. However, you have a chance to defend yourself. The lender must prove that you took out the loan, that you haven’t repaid it, and that they are the proper owner of the debt. Without the right paperwork, they can’t get a judgment. If they do have the necessary evidence to get a judgment, they will most likely get an order for wage garnishment.
If you have no other method of repayment, wage garnishment is not the end of the world. In California, creditors can generally only garnish up to 25% of your earnings after mandatory deductions (taxes and Social Security). However, the government can only collect up to 15% for your federal student loans. Depending on your income, that may be significantly less than even a consolidated loan payment. You may even be “judgment proof,” which means that you don’t make enough money to garnish. Of course, you should also remember that a judgment of this nature would reflect poorly on your credit score, regardless of the amount of the garnishment.
The Bottom Line
Student loans are the some of the largest debts most of us will ever incur, second only to mortgage loans. The average student in California graduates with about $20,000 in debt. It can be overwhelming to think about paying that bill, but you have plenty of options. The key is to maintain contact with your loan servicer or lender or to contact an attorney that is well versed in student loans. The sooner you address a problem with student loan repayment, the easier it is to fix.
Barry Edward Borowitz is the founding partner of Borowitz & Clark, LLP, a leading bankruptcy law firm that represents clients petitioning for bankruptcy protection under Chapter 7 and Chapter 13 of the bankruptcy code. Mr. Borowitz has been practicing bankruptcy law exclusively for more than 15 years. View his full profile here.