Repairing the Damage of Student Loan Default

Q: I defaulted on approximately $5,000 in student loans in early 1982. I tried to make payments after that, but was earning too little money and was never able to get the loan out of default. My credit rating is suffering and I want to clear up this matter. What do I have to do? --C.F.D .

A: The U.S. Department of Education is more than happy to welcome you back into the fold, but it will have to be on the government’s terms. With nearly 5 million student loans worth a whopping $13 billion in default, Uncle Sam is understandably upset at the seemingly wanton abuse of a system originally designed to encourage the more noble pursuits of its young citizens.

Be prepared: There is no amnesty program awaiting you. At the least, you will have to repay your loan--plus interest. According to the debt collection division of the Department of Education, your loan balance has probably ballooned to $9,000, including interest. With penalties, you could be slapped with a bill of as much as $12,000. However, it is possible, department officials say, that the government will forgive the penalties and extra collection charges. But don’t count on it.

To begin repaying your loan, you should first contact your lender or school to find out what process you should follow. If you are unsure who your lender is or if your school has no record of your loan, help is available from the Federal Student Financial Aid Information Center at (800) 433-3243.

Depending on your circumstances--including your income, amount owed and previous repayment efforts--you may be able to negotiate an extended loan-repayment schedule rather than facing a single lump-sum payoff. Further, by making 12 consecutive monthly payments at the agreed upon rate, a taxpayer is considered “eligible for rehabilitation.” If you gain this status, the government will notify the credit-rating bureaus that you are making an attempt to make up your loan default.

However, paying off your loan will not immediately give you a clear credit rating. That is going to take at least seven years from the time the default was entered on your report. It would be less than candid not to tell you that under federal credit-reporting laws, the default notice must be wiped off your credit report seven years after its entry regardless of whether you repay the loan.

However, Department of Education officials say the credit law, which passed in 1985, has prompted them to begin seeking court-ordered default notices to keep the pressure on their deadbeat accounts. Depending on the state in which you reside, the default judgments and renewals could stay on your credit rating for as long as 20 years. Currently, 100,000 defaulted loans are awaiting action at the Department of Justice.

The Education Department has also started attaching the tax refunds of student loan defaulters and earlier this year began an experimental program to attach up to 25% of their wages. “These students signed a contract, and they should live up to it,” says Frank Krebs of the Education Department’s debt collection bureau.

Bank’s Data Demand: Check Legal Basis

Q: The bank that holds the mortgage on a commercial investment I made in 1986 just asked me to send copies of my tax returns for the last three years plus details of all my other real estate investments. I have never missed a payment on this mortgage and the property produces a positive cash flow. What right does the bank have to make these demands and what could they possibly do with the information? --H.H.K.

A: Bankers, a more cautious than usual bunch these days, say there could be any number of reasons for your bank’s request. However, our experts advise that you contact your bank and ask them to give you the legal basis for their request.

“There is no reason this fellow shouldn’t force his bank to state the legal authority for this information,” says Paul Gordon Hoffman, an attorney in West Los Angeles. “If the bank has no legal authority, then he’s under no obligation to comply.”

Bankers, however, say that you may well discover that the fine print of your loan documents gives your lender the right to seek this information. If this is true, why are you just hearing about the loan provision now? It probably has to do with the sorry state of real estate these days, especially here in California.

In all likelihood, your bank is facing increasing pressure from federal regulators to ascertain the value of the loans on its books and the credit-worthiness of its borrowers. A borrower does not have to go into default for a loan to become less certain and stable. With real estate values--once sure to rise in California--now falling, lenders are more concerned than ever about the quality of their loan portfolios. The request you received, whether authorized in your loan agreement or not, most likely stems from your lender’s increased nervousness.

“The pressure is on financial institutions to quantify the risk in their loan portfolios,” said one banker.

What will happen if you do comply with your lender’s request? Probably nothing, if you are current on your loan payments and continue to meet all the requirements contained in the fine print of your loan.

However, if your loan requires a certain loan-to-value ratio in the property and you no longer meet it--or if you must operate your income property on a cash-positive basis and you’re not--you could face problems.

There’s little cause for alarm for the average commercial investor. If your loan contains these provisions, you or your legal and financial advisers are probably well aware of them.