Can You Consolidate Defaulted Student Loans?

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If you’re one of the five million borrowers who have defaulted on their federal student loans, the Direct Consolidation Loan program can get you back on track. To qualify, you must make three consecutive payments or sign up for an income-driven repayment plan. Once approved, your defaulted federal student loans get rolled into one.

A major benefit of consolidating is you get a low, affordable monthly loan payment and you can protect your credit score from further damage. However, you’ll need to decide between rehabilitating your federal student loans or consolidating them.

How to consolidate defaulted student loans

If you have federal student loans, you’ll apply for loan consolidation through the Federal Student Aid website. Before you begin, you must meet one of two requirements, but you can choose both:

1. Agree to pay your new loan under an income-driven repayment plan.
2. Make three consecutive, voluntary, on-time, full monthly payments on the defaulted loan.

While the first option is much easier, it’s also more limiting. By signing up for an income-driven repayment plan, your repayment period will be either 20 or 25 years. Making the three full payments allows you to choose from a wider variety of repayment options.

While consolidating your federal loans gets you out of default, you’ll still be on the hook for collection fees. If you choose the income-driven repayment plan option, you’ll pay $150 or up to 18.5 percent of the principal and interest that’s still outstanding. If you make the three payments, you’ll pay 2.8 percent of the outstanding principal and interest. Regardless of the route you go, your new student loan interest rate will be the average of your current loans.

Pros and cons: Consolidating defaulted student loans

Consolidating defaulted student loans gets you over several hurdles. First, it pulls your loans out of default. This can be accomplished within 30 to 90 days, and can requalify you for other hardship programs. It can also stop even more severe consequences like wage garnishment or seizure of tax refunds.

Consolidation is just one part of the journey. It brings your loan back into good standing, but you will still owe any fees that have been added, and there may already be damage inflicted on your credit report. So after you consolidate, you may consider looking into how to improve your credit score and paying down the fees quickly.

Pros

• You can get on a more affordable repayment plan.
• Your student debt will no longer be due in full.
• You can stop the default from doing further damage to your credit score.
• You may be able to reduce your collection costs.
• You will stop any potential collections from moving forward.
• You may become eligible for loan forgiveness.

Cons

• Unlike with rehabilitation, the default will remain on your credit reports after you consolidate them.
• It may not help if you were previously on an income-driven repayment plan.
• You will still owe collection costs.
• Outstanding interest and fees will be capitalized and added to your student loan balance.
• Certain loan benefits may no longer be available.

The application process to consolidate defaulted federal student loans may take only a few minutes, but it can take between four and six weeks to complete the consolidation process. If you want to make three payments before you start the process, you’ll need to tack on an extra three months to your timeline.

While you’re waiting for the consolidation process to complete, it’s important to keep making on-time payments to show that you’re serious about avoiding default again in the future. This will also ensure you avoid more late payment fees.

Bottom line

Consolidating defaulted federal student loans can be a good way to avoid having to immediately pay the full balance owed. It can also stop your credit score from taking any further damage from your missed payments. However, it’s important to consider all of your options before making a decision.

The option of rehabilitating your loans requires more work on your part, but can remove some of the damage done to your credit. If you do decide to consolidate the debt, consider whether you can make three monthly payments or whether you need to enroll in an income-driven repayment plan.