He recently wrote the New York Times Op-Ed, Why I Defaulted on my Student Loans, arguing that defaulting on federal student loans can be done while still avoiding financial disaster. I disagree.
I won’t take a stance on the morality of paying student loans, although I will say that I have never once met someone who defaulted on their student loans by choice. All of my student loan clients defaulted because of an impossible financial situation — whether it was due to unemployment, medical debt, divorce, or disability.
He dispenses some terrible personal finance advice in his “get out of debt free” plan, which requires that you “live with or marry someone with good credit.” The most compelling part of his story, however, is not in his ill-fated plan. It’s in this statement:
“Forty years after I took out my first student loan, and 30 years after getting my last, the Department of Education is still pursuing the unpaid balance.”
Even a judgment from a lawsuit can’t be collected after 20 years in Massachusetts. What makes a federal student loan so special? The creditor made the rules. When the creditor makes the rules, you find that it is not so lenient when it comes to default.
Federal student loans provide deferral for those with an economic hardship, and discharge of the obligation for those too disabled to work. Federal student loans can also be forgiven if you decide to work for a non-profit or government agency (including schools). Private loans have their own rules, without the flexible repayment options or discharges, but they are less likely to haunt you after thirty years.
What Happens If You Default on Your Federal Student Loans?
- They live forever. Student loans aren’t usually discharged in bankruptcy (it is very rare), and there is no statute of limitations.
- The government will take your money without warning. Every other creditor has to take you to court before garnishing your wages, but the IRS can do that — and more — without the due process of going to court. Not only can it garnish up to 15% of your disposable income, it can take your tax refund and your Social Security benefits — without first taking you to court.
- You lose the flexible repayment options. After you default on your federal student loans, you lose some of the major benefits of having student loans. You can’t get forebearance, deferment, or adjustable repayment options until you first “rehabilitate” your loan. And if you rehabilitate your loan once, you can’t do it again.
- Your debt will increase. Debt collectors for student loans can charge up to 40% of the loan balance in fees. The amount of fees a debt collector can tack on to a student loan depends on the type of student loan.
- Your credit will suffer. Like other creditors, federal student loan servicers report late payments and defaulted loans to the major credit reporting agencies. These reports can remain on your credit report for even longer than seven years, in some circumstances.
If you find yourself in an impossible financial situation, and student loan payments are a piece of that puzzle, you have options before defaulting. Consider applying for a deferment or an income sensitive repayment plan. If you are disabled, consider applying for a disability discharge. You have options.
If you live in Massachusetts or New York, let’s talk.
Editor’s note: A helpful reader pointed out that saying that student loans “can’t” be discharged in bankruptcy is misleading, because there is a procedure for discharging them. That procedure, however, is infrequently invoked and rarely results in a full discharge of student loans. Although it can be done, it’s not typical. – 6/26/15