A defaulted federal student loan isn’t the end of the world.
Let’s say you fell behind on your student loans. Way behind.
So far behind that you went into default on your federal loans. But times got better, and you were able to rehabilitate those loans and resume payments.
Later on, you find yourself in a financial crunch again. One thing leads to another, and you default again.
What’s to be done?
Rehabilitation – A One Shot Deal
In the world of consumer finance and debt, you can fall behind on a loan and then catch up again. Fall behind again and you catch up again.
For all their faults, private creditors and collectors are forgiving in that way. They want their money, and are content to get it when you’ve got it.
In the world of federal student loans, however, the landscape is different. If you default once and rehabilitate your federal student loans, you can’t do it again.
Consider Consolidation
You can’t rehabilitate the federal student loan, but you may be able to consolidate the loan if you agree to repay the loan under either the Income Contingent or Income Based Repayment Plan.
There is, however, a catch. You can’t consolidate a defaulted federal student loan under these circumstances:
- If a judgment has been issued against a defaulted loan (unless the judgment order has been vacated); and
- If you are trying to consolidate defaulted Direct Consolidation Loans and do not include at least one additional eligible loan in the consolidation.
If your defaulted student loan is a FFEL Loan or Direct Loan, you may be liable for collection costs as well as any collection costs of up to 18.5% of the principal and interest outstanding on the defaulted loan.
Federal Loans Eligible For Consolidation
Not all federal student loans are eligible for consolidation, however.
You must have at least one Direct Loan or Federal Family Education Loan (FFEL) loan in order to consolidate under the Direct Loans program.
Even if you have a number of loans, you can consolidate under the Direct Loans program if at least one of them is a Direct Loan or FFEL Loan.
Chapter 13 Bankruptcy As An Option
If your loan is in default and you can’t consolidate under the Direct Loans program, maybe Chapter 13 bankruptcy can help you.
Under Chapter 13 bankruptcy, all of your debts (not just student loans – all of them) are put under the control of the U.S. Bankruptcy Court.
Each month you pay an agreed-upon amount of money to the Chapter 13 bankruptcy trustee appointed in your case, and that trustee distributes the money to your creditors – including your federal student loan lender. At the end of the case, which last 3-5 years depending on your household income and a few other factors, most of your debts are wiped out.
Your federal student loans, however, will not be wiped out at the end of your Chapter 13 bankruptcy case. In that way, you can look at Chapter 13 as a way of forcing a temporary repayment plan on your federal student loan servicer.
In order to qualify for Chapter 13 bankruptcy, you must have regular income as well as the ability to make payments of some sort. It doesn’t need to be a huge number each month, but if you’re running the in negative each month then Chapter 13 isn’t going to work for you.
The Downside Of Chapter 13 Bankruptcy
Using Chapter 13 bankruptcy as a way to handle your defaulted federal student loans isn’t a perfect solution. In fact, here are some of the downsides you need to know about:
- the case runs for 3-5 years depending on your household income;
- during the time that you’re in Chapter 13 bankruptcy, you will need to turn over a portion or all of your tax refunds each year to the trustee for distribution to your creditors;
- interest on your federal student loans continues to accrue during your Chapter 13 case, so your balance may not go down by a significant amount of money by the end of the case; and
- you will not be able to use new credit or borrow money while you’re in Chapter 13 unless you get permission from the court to do so.
The Benefits Of Chapter 13 Bankruptcy
There are, however, lots of benefits to filing for Chapter 13 bankruptcy. They are:
- force a repayment plan of your federal student loans based on what you can afford;
- stop collection activities against you for the period of time that you’re in Chapter 13;
- prevent wage garnishments, bank account freezes and judgments from going forward against you;
- maintain the ability to keep a roof over your head and food on your plate without continuing to slide further behind in your federal student loan obligations;
- wipe out many of your other debts at the end of the Chapter 13 case, which may make it easier to catch up on your student loans over time; and
- if your financial situation doesn’t improve by the end of the case, you can file another Chapter 13 to handle your remaining student loan debt.
Legal Fees For Chapter 13 Bankruptcy
This is a big question for most people – Chapter 13 sounds great, but how am I going to pay for it?
Fair question.
In some places, our Chapter 13 legal fees are set by the court (in Los Angeles Chapter 13 cases, for example, we are limited to charging $4,000 for the basic work involved).
In New York, our fees are based on your situation and what we reasonably expect to do in order to get your the help you need. That usually runs about $6,500.
On top of those fees, there are court filing fees that come to $281. There’s also a credit counseling certification process as well as a financial management certification that you’ll need to do, and they usually come to about $50 combined.
How Legal Fees Get Paid
Your goal is to get this handled as quickly as possible, and we want to help. That’s why we allow you to pay most of your fees through the Chapter 13 Plan.
That means we will stand in line with your other creditors and get paid a little bit each month our of your monthly payments.
It makes sense for you because you get into court more quickly, and you have the peace of mind knowing that we don’t get paid if the case isn’t successful.
Consider Your Options
As you can see, a defaulted student loan isn’t the end of the world. Whether it’s consolidation or Chapter 13 bankruptcy, there are ways to avoid the government’s collection efforts.
I’m happy to help either way, and when we talk it will largely be about mapping out these options and seeing which one works best for you.