What Happens When You Can’t Pay? Part 1

Yesterday, the Department of Education released some good news about student loans. In this press release, the Department announced that the default rate for student loan payments dropped over the past year. Why is this good news? Well, the default rate is the percentage of borrowers who are unable to repay, or default on, their student loans.

To calculate this default rate, the Department of Education looks at all borrowers who started repaying their loans three years ago. The number of those borrowers who were unable to repay their loans at some time throughout those three years represents the default rate. The fancy name for this rate is the “Three Year Federal Student Loan Cohort Default Rate.”

The default rate just released by the government is 11.8%, which means that of the 5.1 million student loan borrowers who began repaying their loans sometime between October 1, 2011, and September 30, 2012, 11.8%, or 611,000 people defaulted on their loans before September 30, 2014. This is a drop from last year’s default rate, which was 13.7%. In fact, the default rate has been trending down recently, as the rate the year before that was 14.7%.

While this is good news, it still shows that there is a significant problem with student loans. The default rate shows us that over 1 in 10 people will default on their loans within three years of starting repayment. Take a look around your class the next time you are in one – 1 out of every 10 of those people will be unable to pay back their student loans at some point. And maybe, one of those people will be you! Hopefully not, and hopefully these blog posts will help you to avoid that.

In this post, I want to go in depth on what happens when you, like 1 out of 10 people, default on your student loans. There are many severe consequences to this that people don’t realize. But before doing this, I think we need to do a quick clarification on a couple things.

First, what exactly does it mean to default on a student loan? The technical definition is “the failure to make payments on your student loan as scheduled according to the promissory note (contract) you signed when you took out the loan.” For most federal loans, the loan will be considered in default if you go 270 days without making a payment. For private loans, when the loan is in default is determined by the contract.

Second, what causes people to default on their loans? There are a lot of decisions people make that unwittingly set them up for default years down the line. I want to take a look at some of these different scenarios, because some of them might happen or might have already happened to you!

1) The Over-Borrower. Someone who takes out way too many loans. They take out more loans than they actually need for tuition, and spend the rest on other expenses. Could also be someone who goes to an expensive university. They graduate with a heap of debt, and quickly realize that they aren’t able to meet the minimum payments on their loans.

2) The Too-Much for Too-Little. This is a person who took out student loans to get a degree that isn’t really feasible for a career. In essence, they paid too much and received too little. We can all make jokes about art majors working at Starbucks, but it is a real and unfortunate phenomenon. Some people take out loans for a degree that will not earn them enough money to pay back those loans! Or worse, some people can’t even find jobs for their degree. This specific situation is covered more in the next point.

3) The Under-Employed. We know our economy has unemployment problems. Something that isn’t talked about as much is under-employment. Under-Employment is when an individual has to take a job in a field that they are overqualified for because there are no available jobs within their field of study. These jobs almost always pay less, and the low pay can cause some people to default on their student loans.

4) The Career-Changer. This person quickly finds out the career field they majored in is not the one for them. Whether the stress level is too high, or they just don’t like it, they leave that field and try to find a job elsewhere. The only problem with this is that it is hard to find a job with an applicable degree. Many people in this situation end up in jobs with lower pay, and are thus unable to make the required payments on their loans.

These situations are all traps to avoid, because falling into them gives you a higher chance of defaulting on your student loans. When choosing what school you’ll attend, what degree you’ll earn, and how many loans you’ll take out, you need to really calculate whether you will be able to pay back those loans or not – you don’t want to be a part of that 11.8%.

Whew, that was a lot of stuff already! And I haven’t even gotten into the topic I actually wanted to cover; what happens when you default on your loans. However, I want to keep things at a manageable level, so instead of overwhelming you with more information, I am going to end this post here. The next post will cover the consequences of defaulting on your student loan payments. Sorry if I misled anyone, and be sure to check out the next post, as it contains some seriously frightening information you won’t want to miss.

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