What to Expect (& Do) After Defaulting on a Private Student Loan

You went to a bank, a credit union, or another private lender, and you asked for a student loan. You got the money, and in return, you agreed to pay that loan back in small installments. It’s all there in the terms and conditions.

But what happens when you can’t pay the bill? 

Defaulting on a private student loan is risky. You don’t have all the protections that come with a federal government loan from the U.S. Department of Education. And it can happen if you miss as few as three payments. 

If you’ve already defaulted on your private student loan, don’t despair. There are options to explore, including:

• Settling your student loan debt. 
• Working with debt collection agencies. 
• Challenging your student loan balance in court. 

No matter what option you try, you’ll need to work to repair your credit rating. That will take a hit. And you’ll need to save up to pay the hefty tax bill if you’re successful in reducing your loan balance.

Can You Settle Your Student Loan Debt?

Defaulting on private student loans doesn’t mean erasing your balance. You still owe money, and someone wants that payment. If your private student loan hasn’t moved into collections quite yet, you might be able to haggle down the balance. 

To make this work, the National Consumer Law Center says you’ll probably need a large, lump sum of money. Be prepared to offer up the entire package as one payment, and if that doesn’t work, consider offering a monthly payment. 

If your lender agrees, take these steps:

• Get it in writing. Ask your loan servicer to describe the terms and conditions in detail. 
• Follow your agreement. Pay on time, as you promised, and watch your bank balance to ensure the payments are processed. 
• Ask for follow-up documentation. When you’ve paid as promised, ask the loan servicer to write you a letter that proves you paid as agreed, and your debts have been satisfied. If someone else tries to collect, this is critical documentation.
• Stay in contact. If a check doesn’t clear, a transfer doesn’t go through, or anything else happens that keeps you from making a payment, call right away. Defaulting on a plan you have worked out is the kiss of death for the deal you made. 

Be aware that some banks won’t work with you. Defaulting on private student loans comes with risks, and sometimes, you’ll have to accept the consequences. They can include wage garnishment, higher credit card costs, and in some cases, you could face a moment when an organization decides to seize assets. 

Contact Debt Collection & Make a Deal 

To clean up the mess defaulting on private student loans makes, loan servicers call in collection agencies. These organizations pay for your loan, and in essence, they take it over from your bank or credit union. Then, they try to get money back from you. If they can make you pay more than they paid for your loan, it’s a great deal for them. And that offers you an opportunity.

When you are tapped by a debt collection agency, the Consumer Finance Protection Bureau recommends asking for:

• Identification. What is the name of the company? Where are they located? What is the company’s telephone number and email address?
• Student loan debt details. How much does the company think you owe, including fees, interest, and collection costs?
• Origin statement. What’s the name of the original lender, and can they confirm this is student loan debt? 

This information must be given in writing, not over the phone or in a text message. Ask for a letter that details this information, and don’t offer any personal data until you have a letter in your hands. 

Once you’ve verified the debt collector, pull together a plan. Think about how much you can pay per month, and determine what day you could make that payment. Then, contact the organization and explain your plan.

The Consumer Finance Protection Bureau recommends recording any telephone conversations about the plan and asking for a written recap of the details before you start paying. 

Fight Your Student Loan Debt in Court 

Banks and credit unions must keep mountains of paperwork to prove that you have student loan debt and they are entitled to your money. Sloppiness could work in your favor. If your student loan servicer takes you to court, you could win.

You could win in a courtroom if:

• The bank can’t prove ownership. The New York Times reports that tens of thousands of students had their private student loan balances wiped away because the banks couldn’t prove they owned the debt. 
• It’s been too long. States put limits on court dates. If the bank tries to sue you for your student loan debt and it’s been longer than your state allows, your debt could be forgiven. 

If you’re taken to court, you’ll need a lawyer to make sense of the proceedings and defend your best interests. But you could walk away with no loan balance at all. 

Prepare to Repair Your Credit 

After defaulting on private student loans, you’ll have some cleanup work to do. You’ll start by looking at your credit score.

A credit score helps other lenders assess your risk. Should they loan you money? Or will they lose money by giving you anything? Your credit history helps companies answer those questions. 

Your credit score will dip due to:

• Missed payments. Every time you don’t send a check, it is documented in your report, and the data will stay there for seven years.
• Multiple players. Every time your loan is passed to someone else (like a collection company), it shows up on your report. Sometimes, it looks like a new debt. 
• Fines and fees. Every bit of added money due to your inability to pay your loan looks like new debt. 
• Student loan default. When your loan moves into default, it also stays on your report for seven years.

You can’t make time move faster. But while you wait for the seven years to pass, you can pay every bill you have on time. You can borrow money and pay those balances back. Those small steps help to repair your credit. 

Save Up for Taxes

Despite a victory in defaulting on private student loans, and a wiped clean balance, you will not be out of financial trouble quite yet. 

Experts say that any forgiven balance looks, to tax collectors, like earned money. If you’re in debt from private student loans for $100,000 and $75,000 of that is forgiven, you’ll owe taxes on that $75,000.

Start saving for your tax bill as soon as you know you’re moving into default. There’s no way to get rid of your tax bill. You’ll need to pay it. And while that hurts, remember: What you’ll pay in taxes is probably lower than what you owe on your loans. In the end, you’ll come out ahead.