How Do You Rehabilitate A Defaulted Loan?

Rehabilitation of a loan is a process that allows borrowers who defaulted on their student loans to restore their good credit rating. It can be done with both government loans and private loans. The rehabilitation is a two-way street - the borrower agrees to repay his debts and the lender agrees to have the banks delete the records of non-payment. However, it is important to remember that the rehabilitation is strictly a one-time deal. If the borrower does not fulfill his or her obligation, he or she will not get another try.

Step 1 - Setting the terms

The borrower must contact the lender, be it the government or a private institution, and inquire about student loan rehabilitation. The lender and the borrower should negotiate a reasonable payment plan. Once that is taken care of, the borrower signs the agreement and the rehabilitation process begins. If the private lender insists that the loan cannot be rehabilitated, the borrower should contact US Department of Education's Ombudsman's Office to help with the negotiations.

Step 2 - Making the initial repayments

To prove his or her commitment to the rehabilitation process, the borrower must make no less then nine and no more then twelve regular monthly payments (this number is agreed upon during Step 1). The payments must be on time. The payments secured on involuntary basis, such as through wage garnishment or litigation, do not count towards that total.

Step 3 - Removing the default status and fulfilling obligations

When the borrower makes all the initial required payments, the lender instructs the credit reporting agencies to remove the information about the defaulted loan from the borrower's record. From that point on, the borrower is once again eligible for benefits such as deferment and forbearance. The borrower must repay anything he or she still owed after the initial required payments. The repayment plan will be the same as it was before the loan defaulted, and the penalties will be the same as well. As mentioned before, the borrower must do everything in his or her power to prevent another default - if he or she fails to do so, the new default will remain on record forever.    

Things to watch out for

In addition to everything listed above, there are several things that borrowers should keep in mind when filing for rehabilitation of defaulted loans. They include:

  • The monthly payments will probably increase - This is true for both the initial required payments and the subsequent payments.
  • The interest rate will accumulate - any interest that built up before the borrower defaulted on the loan will be added to the outstanding balance once the rehabilitation process begins, increasing the amount of money the borrower will have to pay back.
  • Rehabilitation doesn't wipe the slate completely clean - While the default will be wiped off the record, the same is not true for any prior delinquencies.

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