The hidden perils of private student loan default

Falling behind on private student loan payments may result in student loan default. When you default on your private student loans, lenders report it to the major credit bureaus, lowering your credit score. These lenders may also use collection agencies to pursue your unpaid debt and/or sue you for late payments.

The impact of defaulting on private student loans extends far beyond financial consequences. It can create significant emotional stress and strain personal relationships, especially if family members or friends have co-signed the loan. The constant pressure of unpaid debt can lead to anxiety, depression, and a sense of hopelessness, affecting one's overall quality of life. Moreover, defaulting on student loans can hinder career prospects, as some employers conduct credit checks as part of their hiring process. This can create a vicious cycle where financial struggles make it harder to secure employment, further exacerbating the ability to repay the loans.

Understanding Private Student Loans

Private student loans are loans made by private lenders such as banks, credit unions, online lenders, and non-federal government entities. Private student loans, like federal student loans, can be used to pay for school and other educational expenditures such as tuition and fees, room and board, technology and supplies, transportation, and child care.

While you can only get federal student loans if you complete the Free Application for Federal Student Aid (FAFSA) within a certain time limit, you can apply for private student loans at any time while in school. Federal loans provide deferment, forbearance, income-driven repayment (IDR) plans, and debt forgiveness options. Private student loans do not.

It's crucial to understand that private student loans often come with higher interest rates and less flexible repayment terms compared to federal loans. This makes them a riskier option for many students. Additionally, private lenders typically require a credit check and may base interest rates on the borrower's creditworthiness. This can be challenging for young students with limited credit history, often necessitating a co-signer. Borrowers should carefully consider their future earning potential and ability to repay before taking on private student loans, as the long-term financial implications can be significant.

The Consequences Of Defaulting On Private Student Loans

Immediate Consequences

Full balance is due: If you default on your private student loans, you must repay all you owe that has not previously been paid back. Acceleration occurs when the full sum, including all outstanding principal and interest, becomes due at once.

Collections: Your lender may attempt to collect your outstanding debt or refer it to a third-party collection agency.3 These firms, or debt collectors, will contact you in an attempt to collect your outstanding debt. Years after your loans go into default, you may still receive phone calls, emails, and physical letters about your outstanding debt.

Credit Score Drop: Lenders report private student loan defaults to the main credit bureaus, lowering your credit score. This decline reduces your chances of being approved for credit in the future, whether for another student loan or a different lending product. If you are approved for a loan, you may have to pay higher interest rates than you would have if you had a higher credit score.

Long-Term Financial Impact

Wage garnishment: Debt collectors and collection agencies may obtain a court order to garnish your earnings. This implies that a portion of your paycheck will be allocated to your unpaid student loan until you are current on your payments.

Credit report damage: Student loan default might remain on your credit report for up to seven years. This, along with a drop in your credit score, will make it more difficult to qualify for future loans and lower interest rates.

Legal Implications:

Lawsuits: Your lender, debt collector, or collection agency may sue you to recover your outstanding debt. In addition to reducing your income through wage garnishment, attorney costs and other legal expenditures can increase the cost of failing on private debt.

Co-signer problems: While you will not have your tax refund or Social Security check seized if the original borrower defaults, you may still be hauled to court and legally obliged to repay the outstanding loans as a co-signer.

The ripple effects of defaulting on private student loans can extend to various aspects of one's life. For instance, it can impact housing opportunities, as landlords often check credit reports when considering rental applications. A poor credit score due to loan default may result in denied applications or the need for larger security deposits. Furthermore, defaulting on student loans can affect professional licensing in some fields, potentially jeopardizing career advancement. In extreme cases, some borrowers have even reported difficulty obtaining security clearances for certain government jobs due to their defaulted student loans, highlighting the far-reaching consequences of loan default beyond just financial matters.

How to Avoid Defaulting on Private Student Loans

Communicate With Lenders

Many lenders are eager to assist customers in staying on track with their payments. If you are at risk of default, contact your lender and explain your position. You may be able to arrange a temporary payment plan. You'll need to be willing to compromise to find a solution that works for both of you, but it's still important exploring what options are available before committing to anything.

Look into Repayment Assistance Programs

Some lenders provide hardship programs, while others may be ready to temporarily adjust your loans while you are experiencing a difficult time. You could look into government or nonprofit agency aid programs that provide payback support at the local, state, and federal levels.

Refinance Your Loan

Refinancing your student loan entails taking out a new loan to pay off your previous, existing debt. By refinancing, you will receive a new repayment term and interest rate. Sometimes the new repayment term may be longer, or the interest rate will be lower, lowering your monthly payment. Refinancing does not guarantee a lower monthly payment.

Will Defaulted Student Loans be Forgiven?

Private student loans, whether defaulted or not, are not eligible for government forgiveness options. If you have defaulted on a federal student loan, you are no longer eligible for federal loan forgiveness. You can regain eligibility by merging your defaulted federal student loan into a direct consolidation loan.

Can Bankruptcy Discharge Private Student Loan Debts?

Bankruptcy can potentially cancel private student loan debts.9 However, not all borrowers will be eligible to discharge their student debt in bankruptcy, since it is determined by the type of bankruptcy filing, the type of loans taken out, and the borrower's specific circumstance.

How Does Default on a Private Student Loan Affect Co-Signers?

When you miss payments or default on your private student loan, your credit score suffers—as does your co-signer's. A co-signer is just as accountable for a loan as the original borrower, and they may face legal consequences if you are unable or unwilling to return your debt.

The impact on co-signers can be particularly devastating. Co-signers, often parents or close relatives, may find their own financial futures compromised due to the borrower's default. This can lead to strained family relationships and create long-lasting emotional and financial trauma. In some cases, co-signers have reported difficulty retiring on time or being forced to postpone major life events due to the unexpected financial burden of a defaulted student loan. This underscores the importance of both borrowers and co-signers fully understanding the risks and responsibilities associated with private student loans before entering into such agreements.

If you default on a private student loan, you may suffer short- and long-term financial implications. Your credit score may suffer, and you may have difficulty applying for other loan products. A defaulted debt will remain on your credit report for several years. Defaulting on your loan might also have a severe financial impact on your co-signer. Before taking out a private student loan, think carefully about the consequences of defaulting.