Default on a Student Loan? What to do

By Eric Reed

NEW YORK (MainStreet)--Earlier this month, the Senate rejected a proposal to reset interest rates on student loans to their pre-July 1 level of 3.4% instead of doubling to 6.8%. Now, lo and behold, another group of Senators is trying to push through a compromise whereby undergraduates with Stafford loans would pay an interest rate of 3.85% next year. Either way, those with higher education loans are in dire straits.

A snapshot: existing student loans have grown into a trillion dollar marketplace that involves one in every five American households--and for households headed by someone under 35, it's two out of every five for everyone wondering why Millennials aren't yet buying houses, cars or yachts. No matter how you slice it, student loans are big and getting bigger.

So inevitably there are folks out there are concerned about defaulting on a student loan. But what happens if you don't pay?

For a government backed loan, default happens after 270 days of missed payments. The results get nasty pretty fast, and not least because it does serious damage to your credit rating. In the face of default government and private agencies gain immense powers of collection, sometimes well beyond their authority for ordinary debts. For example, while debt collectors typically need a court order to garnish your wages, according to Illinois Legal Aid, to collect a student loan, they get to skip that step and seize 15% automatically through administrative garnishments.

Other items on the parade of horribles include seizing any tax refunds, garnishing Social Security benefits and, of course, a good old fashioned lawsuit.

Your options after a default are somewhat tighter.

First of all, according to Chicago attorney and debt specialist Jarome Lamet, forget about bankruptcy. Although a recent Ninth Circuit decision showed some movement on the issue, as a general rule, student loans simply are not dischargeable through the courts.

"Prior to 2005 if I had a student loan I could go into the bankruptcy court and file a Chapter 7," Lamet said, referring to 2005's bankruptcy reform. "Today you cannot use a bankruptcy court for a student loan, private or government backed."