Student loan debt is crippling a large swathe of the United States population, especially the younger demographics from early 20s to the early 40s who may face tens of thousands of dollars of student debt as they enter their very first professional positions. About $1.4 trillion in student loan debt currently exists in just the US.
While many young people work diligently to pay off their student loan debt, the unexpected can always occur, leading to missed payments and eventual default. The loss of a job, an unexpected major illness or injury, or other unpredictable expenses can throw a budget off entirely.
What Is Defaulting?
In the simplest terms, when a debtor defaults on a debt, the creditor considers the terms of the loan agreement broken and demands repayment in full, immediately. For example, if you hold $20,000 in student debt and only pay off $1,000 in monthly payments before you miss several payments in a row, the creditor may consider that defaulting based on the terms of your contract. If the contract states the loan enters default after three consecutive missed payments and you miss three in a row, the loan goes into default. If the creditor decides to defer to the acceleration process, the balance is due immediately.
Consequences of Defaulting on Your Student Loan
It is essential for anyone who considers taking on student debt to understand the repayment terms and develop a realistic budget that accounts for loan repayments. For example, if you take out a student loan to get a degree in a field with very minimal job prospects, you will likely have difficulty finding a job after completing your degree and may struggle to repay your loan.
The first major consequence of defaulting on your student loan debt is damage to your credit score. Three credit bureaus track Americans’ creditworthiness and assign them scores based on their credit history. Defaulting on a loan, any loan, is a major blow to an individual’s credit score. The initial report of the default to the credit reporting companies starts a domino effect; missed payment notifications and other negative reports will continue to accrue, tanking the debtor’s credit rating significantly.
Defaulting on a student loan debt can also lead to financial penalties in the form of additional fees. Depending on the creditor, the penalty for defaulting on a loan can be as much as 25% of the total value of the combined principal and interest balance. Collections charges can add up tremendously in a very short time. Additionally, the creditor may simply sell the debt to a collections agency, which have notorious reputations for being aggressive in their attempts to collect on unpaid debts.
The potential ramifications of defaulting on student loan debt do not stop with credit score damage and fees, unfortunately. It is possible for a creditor to file a lawsuit in an attempt to collect a debt, or the IRS could seize the debtor’s tax refund in an attempt to settle an unpaid debt. Wage garnishment is also possible depending on the type of loan and the creditor; this means the creditor takes a portion of every paycheck the debtor earns.
Many tools exist to help debtors escape default, such as consolidation and loan rehabilitation, and it may also be possible to refinance some debt through another creditor for more agreeable interest rates and repayment terms.