Editorial Policy

Student Loan Defaults: A Credit Nightmare

default author image

By Eva Norlyk Smith, Ph.D.
September 20, 2011

If you’re struggling to repay your student loans on a limited – or nonexistent — income, missing a payment may seem like your only choice.

However, student loan defaults can potentially impact your credit for the rest of your financial life, say experts.

“A lot of young adults don’t realize the downside of not paying off their student loans. It can literally mar your credit score and financial options for life,” says John Ulzheimer, President of Consumer Education at SmartCredit.com.

Financial prospects for many recent grads remain dim
Before the economic crisis, a college degree used to provide a golden ticket to high-paying employment, a long prosperous career and a comfortable middle class lifestyle.

However, in the wake of high unemployment and stagnant wages, a college degree no longer provides a key to well-paying jobs, nor does it offer the protection against economic hardship it once did. And with the costs of education up sharply over the last ten years, many college graduates now find themselves with poor job prospects and sky-high student loans.

Not surprisingly, the signs of financial distress among college graduates are growing. From 2006 to 2010, the percentage of people with a bachelor’s degree filing for bankruptcy increased from 11.2 percent to 13.6 percent, according to a recent survey by the Institute for Financial Literacy. In the same period, the percentage of people with a high school degree (or who did not finish college) declaring bankruptcy actually went down, reports the Washington Post.

Student loan defaults are also on the rise. From 2008 to 2010, the default rates on federal student loans rose from 7 percent to 8.8 percent. The default rates on loans for for-profit colleges (with higher tuition costs) were even higher, increasing from 11.6 percent to 15 percent in the same period of time, according to the Wall Street Journal.

“The financial challenges faced by young college graduates present a serious problem right now,” says David Jones, President of the Association of Independent Consumer Credit Counseling Agencies (AICCCA). “An estimated 43 percent of recent college graduates of the last two years are living at home. The student loans for a 4-year degree often run as high as $70,000, which is huge.”

The financial impact of a missed student loan payment
Not only are student loan burdens exploding, people with student loans enjoy fewer protections than other types of loans. And, unlike for other types of debt, defaults on student loans can have lifelong consequences.

“Student loans are not subject to the same statute of limitations as are credit cards, car loans and mortgage loans,” notes Ulzheimer. And the repercussions for not paying a bill can last far longer than many consumers may expect. For example:

  • Most student loan debt is not wiped out in bankruptcy. Unlike other types of loans, student loans guaranteed by the government are not discharged if a person declares bankruptcy. The debt will be with you until you pay it off, or die, says Ulzheimer.
  • Student loans have few consumer protections. The Fair Credit Reporting Act lays down a number of protections for consumers with excessive debt. However, student loans fall under the Higher Education Opportunity Act, which offers none of those protections.
  • Defaulted student loans can stay on your credit report for life. Other loan defaults cannot be reported on your credit report for more than seven years after the default, giving people a chance to start afresh. However, defaulted student loans can continue to stay on your credit report for seven years from the date the loan is paid off. If someone never pays off the student loan, this means that the loan, in theory, can stay on the credit report indefinitely.
  • Student loan defaults can have serious repercussions. For most other loans, lenders have limited recourse, if someone defaults on the loan, says Ulzheimer. Not so for student loans. Defaulting on student loans can lead to all sorts of undesirable consequences, including garnishment of wages or Social Security, seizure of tax returns and inability to apply for government loans like VA or FHA loan programs.

For college graduates struggling with student loan payments, David Jones says the best strategy is to be proactive as early as possible. If necessary, seek the advice of a credit counselor with a nonprofit agency, who can help you explore the best options based on your financial situation.

Consolidating loans can also be an important first step to getting on top of loan payments. In addition, a credit counselor can help you find ways to save money to meet loan payments and look into whether re-amortizing the loan to lower the monthly payments would make sense.

Most important, Jones says, is to seek help sooner rather than later so that you don’t wind up curtailing your financial options for longer than necessary.