Credit Advice » Debt » Managing Debt » I’ve defaulted on my student loans. Should I consider loan rehabilitation?

I’ve defaulted on my student loans. Should I consider loan rehabilitation?

Dear Experian,

I had some financial difficulty last year and defaulted on my student loan in an amount close to $5,000. I have the money to pay it off in full, but my situation is that I’m about to buy a house. I could get on a payment plan and have the default lifted as if it never happened on my credit report in nine months
(in which case I’d be paying additional interest in those 9 months), or I could pay it off now in full but the default would be on my credit report for seven yrs.

The amount would be paid now, but I would have a paid government claim showing on my report. Seeing as I’m about to buy a house, realistically, would the payoff now and that scar of seven years affect my loan that much, or should I hold off on my plans until after a nine month payment plan after which the default goes away?

How would each reflect when I go to apply for the loan, and would paying now prevent me from getting a home loan?

– SJJ

Dear SJJ,

It sounds like you are referring to participating in a student loan rehabilitation program. In order to rehabilitate a student loan that is in default, certain stipulations must be met. According to the Federal Student Aid website:

“To rehabilitate a defaulted Direct Loan or FFEL Program loan, you must agree in writing to:
• make nine monthly payments,
• make each payment within 20 days of the due date, and
• make all nine payments during a period of 10 consecutive months.”

Should I Consider Student Loan Rehabilitation?

Student loan rehabilitation can be beneficial for a couple of reasons. Once you have successfully rehabilitated a loan, you become eligible again for benefits such as forbearance, deferment, payment options, and loan forgiveness.
When you successfully complete rehabilitation on a student loan, it will be updated to show that it is no longer in default.

However, the late payments reported on the account prior to the rehabilitation will still remain on the report for a period of seven years. Successfully completing the rehabilitation program will not remove the account or the late payments from your report any sooner.

What is a Government Claim?

You mentioned that you have a loan with a status of government claim. A government claim means that the loan was insured by the government, and that when you defaulted on the loan, the credit grantor filed a claim with a governmental agency to recover the balance due.
Once the government pays the loan, the account will no longer reflect a balance, but the account will still appear on the report as a government claim for seven years from the original delinquency date.
Although the government may then open a new student loan account in your name for purposes of repayment, the status of “government claim” on the original account will not change once you have paid the debt on the new account.
Most likely, the loan you have been offered a rehabilitation program on is the new loan that was opened after the original loan was paid by the government.

Should I Pay Off My Student Loan Before Applying for a Mortgage?

Since you now have the means to pay the new loan off in full rather than making payments under the rehabilitation program, there are several things you should consider:
• the amount of interest to be saved by paying the loan off now
• whether eliminating the monthly payment due on the loan before applying for your mortgage could help you qualify
• whether paying the student loan in full now will still leave you with the down payment needed to qualify for the home loan

Before deciding whether to rehabilitate the loan or pay it in full immediately, you should contact the lender offering the rehabilitation to verify exactly how the lender would report the loan in each instance, whether it is paid in full now or after completion of the loan rehabilitation program.
Once you have confirmed how the account will be reported by the lender on your credit reports with each option, you can contact a mortgage professional to discuss your situation and receive guidance about which option would be more beneficial to you.

Thanks for asking,
The “Ask Experian” Team

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