Student Loan Rehabilitation vs. Consolidation: Which is Better?

After you miss 9 monthly payments on your federal student loans, your loans will default. And when that happens, you’ll have three options to fix the default status: settlement, student loan rehabilitation, and loan consolidation. Settling federal student loans is expensive. As a result, most borrowers end up choosing between rehabilitation and consolidation. Each option has its pros cons. But both will help you get out of default so you can regain eligibility for affordable payments under an income-driven repayment plan, and loan forgiveness programs.

In deciding student loan rehabilitation vs. consolidation, here’s what you need to know.

In my experience as a student loan lawyer, I typically recommend loan rehabilitation over consolidation if:

• the collection fees are going to be waived and

• the borrower has a reasonable shot of paying off their student loan debt

In contrast, I usually recommend consolidation if the borrower:

• needs to get out of default quickly to prevent wage garnishment or to qualify for an FHA mortgage

• works in public service and would be eligible for the Public Service Loan Forgiveness Program

• has a Parent Plus Loan and would gain eligibility for the income-contingent repayment plan

• has a low likelihood of paying back their loans

• needs a simple process to get their loans out of default quickly and manage their student loan payments going forward.

To help you decide which is best for you, here are the pros and cons of rehabilitation vs consolidation.

Benefits of Student Loan Rehabilitation

• Stops wage garnishment: Loan rehabilitation is your only option, aside from bankruptcy, to stop a wage garnishment after it starts. You cannot consolidate a defaulted loan once a wage garnishment for that loan starts.

• Waive collection fees: The U.S. Department of Education agrees to waive collection fees after completing the rehabilitation process. However, if you have loans made under the Federal Family Education Loan Program or the Federal Perkins Loan Program that are owned by a guaranty agency or school, completing the rehabilitation program may leave collection fees in place.

• Removes default status: Your credit report will be updated to show your loans are in good standing. However, the late payment history will remain.

• Eligible for financial aid: You regain eligibility for Federal Student Aid (e.g., grants, federal student loans, etc.) after your sixth monthly payment.

• Eligible for affordable payments: Not only do you regain eligibility for forbearance and deferment, but you also regain eligibility for income-driven repayment plans.

Note: Borrowers are not required to make payments to complete the student loan rehabilitation program until September 2022.

Drawbacks of Rehabilitation

• Have to deal with collection agencies: You have to deal with the collection agency that has your loans. You can’t request a different collection agency.

• Lost paperwork: Borrowers have reported issues with collection agencies saying they never received the paperwork necessary to complete the loan rehabilitation program (e.g., Rehabilitation Income and Expense Form or Loan Rehabilitation Agreement Letter). As a result, borrowers have had to restart payments even after paying for 9 consecutive months.

• Loans reappear: If the student loans were no longer on your credit report, completing loan rehabilitation will reinstate the loans on your credit report. However, the past late payment history and default status should not reappear.

• Takes a long time: Getting out of student loan default with loan rehabilitation takes at least 9 months.

• Rehabilitation payments don’t count: The monthly payments you make while rehabilitating your loans don’t count towards loan forgiveness and your payment amount usually isn’t enough to lower your balance. Most of your money goes towards collection fees and interest.

Benefits of Consolidation

• Stops collection activity: Consolidation can stop wage garnishment, Social Security Benefit offset, and tax refund offset before they start. However, if the student loan garnishment has already started, you cannot consolidate.

• Returns loans to good standing quickly: No matter which loan servicer you choose, it should take about 6-8 weeks to complete the consolidation process. So if you wanted to get out of default to protect your tax refund from offset, consolidation will allow you to file your tax return much sooner than would rehabilitation.

• Lets you choose loan servicer: If you were unhappy with your previous loan servicer, you get to choose the loan servicer you want to work with.

• Gives you one monthly payment: If your federal loans were with more than one loan servicer before you defaulted, consolidation will put all of your federal student loan debt in one place.

• Qualifies you for better benefits: Direct Consolidation Loans give most borrowers the greatest selection of repayment options and access to loan forgiveness programs. Plus, if the federal government does forgive student loan debt, having a Federal Direct Loan increases the chances that some of your loan balance will be forgiven.

Drawbacks of Consolidation

• Increases your loan balance: Consolidation adds the accrued interest and collection fees to your loan balance. Depending on your interest rate, your loan balance can grow exponentially in a short period.

• Lose credit towards forgiveness: Student loan consolidation gives you a brand new loan. Because you have a new loan, you will lose credit you’ve earned towards loan forgiveness under the Public Service Loan Forgiveness Program or IDR Plan forgiveness.

• Default status stays on credit: Both the late payment history and default status will remain on your credit report until they fall off in 7+ years.

• Lose rights and defenses: A handful of federal student loan borrowers have rights and defenses they can raise to discharge their loans due to bad acts by their school or third parties. Consolidation may cause you to lose some of those rights and defenses.

You can consolidate student loans after rehabilitation. Some student loan borrowers consolidate after completing the rehabilitation program to avoid paying interest on the collection fees, which were added to your loans after you defaulted.

‍The Department of Education typically waives collection fees after rehabilitation.

Completing the rehabilitation program and then consolidating will avoid having collection fees added to the principal balance of your new Direct Consolidation Loan.

Consolidation and rehabilitation impact student loan borrowers’ credit scores about the same.

Neither one removes late payments from your credit report. Late payments will remain a part of your credit history until they fall off in 7+ years.

The only difference to your credit score between consolidation and rehabilitation is that completing the loan rehabilitation program removes the default status from your credit report. Loan consolidation pays off the defaulted loans with a new Direct Consolidation Loan. But the default status remains a part of your credit history.

Exactly how much the default status means to your credit score is unclear.

Because of that, it’s my belief that the potential impact on your credit score shouldn’t influence your decision whether to consolidate or rehabilitate.

Note: A report from the Government Accountability Office suggests that borrowers with lower credit scores who got the default status removed from their credit report saw a sizable increase in their credit scores.

If you’re struggling to choose between loan rehabilitation and consolidation, I get it. That’s why I’m here to help — simply schedule a talk with me.

I can get a general idea of what’s going on with your federal and any private student loans you have, and assess your best options. From there, we can create a game plan that best fits your needs and sets you up for student loan success.