Defaults on federal student loans rose to 6.7 percent last year from 5.2 percent a year earlier, the highest default rate since 1998.
In general, if you fail to make payments on a federal student loan for nine months, the loan will be considered in default. Your loans probably will be turned over to a collection agency, and your credit report will be trashed. Unlike private lenders, the federal government can garnishee your wages without going to court, said Margaret Reiter, an attorney and co-author of Solve Your Money Troubles . There's no statute of limitations on collection of federal student loans, Reiter added, which means the government can go after you for the rest of your life.
Filing for bankruptcy probably won't solve your problem. Under federal bankruptcy laws, it's not enough to show that you can't afford to repay your loans now. You also must convince the bankruptcy court that you'll be unable to repay them in the future. This standard is extremely difficult to meet, Reiter said.
Fortunately, there are steps you can take to avoid default. Options include:
• Deferment. This option is available for borrowers who are still in school, unemployed or experiencing other types of economic hardship. Payments are typically deferred for up to three years.
If you have subsidized federal student loans, which are provided to borrowers who demonstrate financial need, the government will pay the interest during deferment. If you have unsubsidized Stafford loans, interest will accrue during the deferment period. Deferment is not automatic. You must apply for it through your lender.
• Forbearance. In this case, your lender will allow you to postpone payments, or pay a smaller amount, for up to three years. Forbearance is granted at the discretion of the lender, and the requirements are generally less stringent than those for deferment, said Robert Murray, spokesman for USA Funds, a company that guarantees student loans.
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