For many defaulted federal student loan borrowers, loan rehabilitation is the best option for getting out of default. You are allowed to rehabilitate a defaulted loan only once per loan (unless the prior rehabilitation was completed prior to August 14, 2008) so it’s important to have a plan in place for affordable payments after rehabilitation is complete before you start this process. If you don’t think you will be able to afford your payments under any plan post-rehab, it might be a better strategy to stay in default until your financial situation changes. Remember, collection costs are added every time you default so if you were to rehabilitate, then default again, you would not only have a much higher balance, but one less option to resolve the default.
How Loan Rehabilitation Works
To be eligible for loan rehabilitation you must make nine consecutive on-time payments (within 20 days of the due date) in an amount agreed to by both your loan holder and you. The initial payment you will be offered 15% of your adjusted gross income minus an allowance for your family size. Here’s an example:
AGI = 35,000
Family size = 2
150% of the poverty level for family size of two in Massachusetts = $24,360
$35,000 – $24,360 = $10,640
$10,640 x15% = $1,596
$1,596/12 = $133
You can calculate your estimated rehabilitation payment yourself with this calculator Payments under loan rehabilitation can be as low as $5.
If you cannot afford that payment, you can request a financial hardship form from the loan holder. This form takes your reasonable living expenses into account and will usually lower the rehabilitation payment below the initial calculation described above. But please use caution. There are no repayment options post-rehabilitation that take your expenses into account so if you cannot afford your rehabilitation payment offered initially, you should think through whether now is the best time for you to use this option. Rather than risk defaulting a second time, you may want to consider waiting to rehabilitate your loans until you are in a financial position to ensure long term success.
You will also be required to sign and return a loan rehabilitation agreement. Failure to do so will mean the rehabilitation cannot be completed, and all other collection activity will resume. You will also be required to begin the rehabilitation process from scratch.
Benefits of Loan Rehabilitation
There are many benefits to loan rehabilitation. They include:
- A reduction in collection costs to 16% (from a possible 24%)
- Remember, if you start loan rehabilitation within the first 60 days after you default, no collection costs at all will be added – but you also have to see the program to completion
- A removal from your credit report of the default line. Note the delinquencies that led up to the default will remain per the usual time frame (usually 7 years) but the default line is removed like it was never there
- The loan is put back in good standing and again eligible for lower payment options, deferment and other benefits
- After the 5th on-time payment, any existing wage garnishments are ceased.
- After the 6th on-time payment, you are again eligible for federal financial aid
- Note that if you do not complete the rehabilitation process, you will again be in default, wage garnishment will resume (the cessation option is only allowed once) and you will lose your financial aid eligibility. You will have to start the rehabilitation process from scratch at that point.
What to Expect Post-Rehabilitation
After you have completed your 9th consecutive on-time payment and returned the loan rehabilitation agreement and any other requested documentation, the loan will be transferred from the collection agency to a loan holder. It is strongly recommended that you apply for the payment option that is right for you right away. Remember, you can only rehabilitate once per loan and significant collection costs are added each time you default. You can read about your repayment options here.