Student Loan Rehabilitation Vs. Consolidation: Which is Best for You?

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Updated on Tuesday, February 19, 2019

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Americans owe more student loans than ever before, so it’s not surprising that rates of default are up, too.

But while default can trigger all kinds of bad consequences, there are a few strategies for fixing the situation, including student loan rehabilitation and student loan consolidation.

Read on to learn how each of these processes work, along with a comparison of student loan rehabilitation versus consolidation so you can decide which strategy is better for you.

How student loan rehabilitation works

Federal student loans are considered to be in default after the borrower goes for 270 days without making payments. Defaulting on your loans can tank your credit score, as well as lead to garnishment of your wages, your tax refund or even your Social Security benefits. Plus, debt collectors could start calling your friends and family, which can add even more stress to an already tough situation.

Student loan rehabilitation is one way to get your federal student loans out of default and back into good standing.

To rehabilitate your defaulted student loan, you’ll need to agree in writing to make nine monthly payments within 20 days of the due date and within a period of 10 consecutive months. This payment will be determined by your loan holder, and it will typically be 15% of your annual discretionary income (i.e., the money you have left over after your necessary expenses) divided by 12.

Let’s say, for example, that you make $30,000 per year, and your annual expenses amount to $20,000. Your discretionary income would be $10,000, and 15% of that would be $1,500. After dividing that total by 12, your loan servicer would ask for nine payments of $125.

If your bill still feels too burdensome, you can ask your loan servicer to recalculate the payment based on your income and expenses. According to Federal Student Aid, your payment under a rehabilitation agreement could be as low as $5 per month, depending on your income.

Note that only voluntary payments count toward this nine-payment requirement, so if your loan servicer has started garnishing your wages, those garnishments don’t count.

Once you’ve made all nine payments, your loans will get taken out of default status and return to good standing. They’ll once again become eligible for federal programs and repayment plans, such as income-driven repayment plans or deferment.

What’s more, your default will be removed from your credit report, so any financial institutions you work with in the future won’t see that you defaulted on your loans. However, your credit report might still contain any late payments that your lender reported before your loan fell into default.

Note that applying for student loan rehabilitation is a one-time option. If your loans go into default again, you won’t be able to resurrect them through rehabilitation a second time.

Advantage to student loan rehabilitation

  • Your required nine monthly payments won’t exceed 15% of your discretionary income.
  • Your default will be removed from your credit report.

Disadvantage of student loan rehabilitation

  • It takes 10 months before your loan is out of default.
  • Your late payments might stay on your credit report, dragging down your credit score.
  • You can only apply for student loan rehabilitation once.

How student loan consolidation works

Your second option for getting your loans out of default is through consolidation. When you apply for consolidation, you essentially give back one or more of your old loans to the government and take out a new Direct Consolidation Loan in their place.

If you consolidate multiple loans, you’ll only have to deal with one loan with a single monthly payment moving forward. Simplifying repayment like this could make it easier to keep up with your bills and track your repayment progress.

You have two options for consolidating your defaulted student loans.

  1. Apply for Direct Loan Consolidation and agree to pay your new loan off on an income-driven repayment plan, such as Pay As You Earn or Income-Based Repayment.
  2. Make three consecutive, on-time full monthly payments, after which you apply for consolidation. Your loan holder will determine the amount of this payment.

After you consolidate, your loan will be back in good standing and become eligible again for federal benefits. But your default will remain on your credit report, which could be a red flag to lenders if you try to borrow money or open a line of credit in the future.

Advantage to student loan consolidation:

  • Your loan will get out of default faster.
  • You can apply for consolidation more than once if you go into default again.

Disadvantage of student loan consolidation:

  • Your default will stay on your credit report.

Another option for getting out of default: Pay your loans off in full

Before comparing student loan rehabilitation versus consolidation, it’s worth mentioning you have a third option for getting your loans out of default: paying off your debt in full. If you make a lump-sum payment for the entire balance of your defaulted loan, you’ll get out of default as well.

Of course, paying off your loans in full is probably not realistic, especially if financial difficulties led you to defaulting in the first place. But if you have the option — perhaps you get an unexpected windfall of cash — paying off your defaulted loan could mean an immediate end to wage garnishment and the other challenges of defaulting on debt.

Student loan rehabilitation vs. consolidation: Which approach is right for you?

Assuming you can’t pay off your defaulted student loan in full, you’ll need to choose between rehabilitation and consolidation. So when it comes to student loan rehabilitation versus consolidation, does either emerge as the winner?

Well, consolidation helps you get out of debt a lot faster than rehabilitation. The consolidation application typically takes between 30 and 90 days, whereas rehabilitation won’t revive your loan for 10 months. If you’re looking to resolve your default ASAP, consolidation would probably be the way to go.

But if your bigger concern is your credit report, then you might prefer rehabilitation. With this approach, your default gets removed from your report, and potential lenders won’t see it.

Both rehabilitation and consolidation are useful options for getting your student loans back into good standing, so consider your priorities when choosing which approach to take. Most importantly, be proactive about getting your finances back on track.

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