One of the most severe consequences of student loan default is the possibility of a lawsuit.
Federal student loan lenders, including the U.S. Department of Education, rarely sue defaulted student loan borrowers because the government has so many powerful collection tools at their disposal that don’t require a court appearance.
However, it’s quite common for private student loan lenders to sue borrowers in state court because obtaining a judgment is often the only way they can go after a borrower's property or income. What a student loan lender can do depends largely on state law.
If the student loan default isn’t ultimately resolved, the borrower may eventually be subject to wage garnishment for federal student loans. Federal lenders and the government can garnish wages “administratively.” This means that they don’t need to go through the court system or secure a judgment in order to take a portion of a borrower's wages. All they have to do is find your place of employment and give you notice that they are going to garnish, along with the opportunity to contest that proposed garnishment.
Private student lenders generally don’t have quite the same powers. They have to first go through the court system – they must sue the borrower and secure a judgment. Only then can they potentially go after a borrower's wages – and their powers (or lack thereof) is determined by state law.
Tax Refund Seizures
One of the most powerful tools that the federal government has to pursue federal student loan borrowers is the ability to intercept your federal tax refunds. This is accomplished through a program called the Treasury Offset Program, and it allows the IRS to seize your federal tax refund and apply it to your federal student loan debt.
This can be particularly destructive to lower-income borrowers who may need their tax refund to pay for routine living expenses. This can also be problematic for married couples who file taxes jointly; the couple’s entire joint tax refund can be seized, although in some cases the spouse that is negatively impacted by the seizure may have recourse by filing something called an “injured spouse's claim.”
Luckily, as a general rule, private student loan lenders cannot take your federal tax refunds.
Social Security Offset
The Treasury Offset Program isn’t just about federal tax refunds. The program also allows the federal government to seize a portion of your Social Security payments in some cases. This can have a devastating impact on older borrowers who are often on a fixed income.
Just like with administrative wage garnishment, borrowers are entitled to notice and an opportunity to contest any Social Security offset before it takes place. And under most state laws, private student loan lenders cannot go after a person's Social Security benefits through the state courts.
The Bottom Line
Defaulting on student loans can have very serious and lasting consequences, upending a person's life. But the good news is borrowers may have options to get out of default.
For federal student loans, there are statutory programs available (like rehabilitation or consolidation) that can allow borrowers to cure their defaults, restore their loans back to good standing, and start repairing their credit.