Default Consolidation

There’s an “alternative path” for borrowers in default to obtain a Direct Consolidation Loan with a new repayment plan based on their income and circumstances.

Loan consolidation is the process of obtaining one new loan to cover all of your existing loans. The purpose of consolidating a defaulted student loan is to simplify the payment process and get you back on track.

After consolidating, collection efforts should cease and your credit reporting will be altered (see below).

Right now interest rates are extremely low and private loans can be consolidated with other private loans. For private loan consolidation, you will need to make sure that your credit is good by getting a free credit report.

If you have at least one outstanding Direct Loan (subsidized or unsubsidized ) or FFEL loan, these types of loans can be consolidated for borrowers in default into a Direct Consolidation Loan under the Department of Education guidelines:

Direct Loans

  • PLUS
  • HEALs
  • Perkins
  • FISLs
  • SLSs
  • Other types of federal loans

So, if you have one or more of the loans above and at least one outstanding Direct Loan (subsidized or unsubsidized ) or FFEL loan, then you should be able to apply for a Direct Consolidation Loan under the Department of Education guidelines.

However, if you don’t like the terms or you don’t qualify, you can choose to consolidate with a private company.

Some defaulted student loan collectors claim that borrowers must make six (or even nine) preliminary payments in order to obtain a Direct Consolidation Loan. It is likely that this claim is inaccurate.

Only three preliminary payments (based on the borrower’s circumstances in whole) are required to obtain the Direct Consolidation Loan or, as an alternative, the borrower can agree to the Income Based Repayment (IBR) plan instead (known as “forced” IBR). Submitting the proper paperwork is required.

Once agreed upon, each payment must be made within 15 days of the due date to be considered on-time. Exceptions could be made for military involvements.

If you default with this Direct Consolidation Loan, you will probably not be eligible to reconsolidate.

You may want to try to rehabilitate before consolidating because you can only rehabilitate one time afterwards.

If you have a Perkins loan, you will loose Perkins cancellation rights if you obtain a Direct Loan Consolidation.

Also, a parent PLUS loan will taint a Direct Consolidation Loan and make it ineligible for IBR.

Collection fees of 11.1% of the balance of each loan are incurred and granted to the lender. You pay for them when they are added to your consolidated loan balance, up to 18.5% of the total.

Consolidation, in general, increases the interest cost incurred over time but may reduce your minimum payments. If you want to go back to school, you should be eligible for more federal aid and be able to defer your loans when you successfully obtain a Direct Consolidation Loan.

If a wage garnishment has been issued or a judgement has been entered, it could impede the Direct Consolidation Loan process. In this case, you may want to have a professional contact the lender. Or you might want to consolidate with a private lender.

After consolidating a defaulted student loan, your credit report may show the defaulted loan paid in full. This is because a consolidated loan is a brand new loan. However, rehabilitation under the Department of Education guidelines might remove it completely without any mention of default because it is the same loan managed by another lender. The amount of information removed by a consolidated loan AND loan rehabilitation is questionable at best. Don’t assume that rehabilitation will remove negative credit reporting completely. (More on this topic later.) Right now, extensive information about credit reporting is beyond the scope of this website.

Both federal and private loan consolidation will come with new conditions. If your monthly payment amount is reduced, the total number of payments can increase. Borrowers should read the fine print before consolidating.

The rules for consolidation loans have not been fully or even adequately described herein. Each lender will have their own rules.