If you are in default on your federal student loan payments, federal law provides two very powerful options for getting out of default: rehabilitation and consolidation. Most lenders will offer both to you, with little explanation of the pros and cons of each. But there are differences between the two, and it’s important to understand which is the better option in your particular situation.
If you are behind a few months in your student loan payments, you are technically not in default. But, once one payment is more than 270 days late, your loan is in default.
Consolidation is the process of obtaining a single new loan to pay off your existing loans. Instead of multiple smaller loans, you will now have one larger loan. Unlike a private loan, with a federal student loan, you do not need to apply for credit to obtain a consolidation loan. (Get the details on student loan consolidation.)
Rehabilitation is a program where you make nine payments that are reasonable and affordable to you, regardless of what your actual student loan payment may have been before you defaulted. After the last payment, your loan is rehabilitated, and you are out of default. (Get the details on student loan rehabilitation.)
The main benefit of both is that both will get you out of default. Being out of default means that you will have the right to defer or forbear your student loan payments, when and if needed. More importantly, it also means that you will be eligible to qualify for income-based repayment plans. These plans allow your payment to be as little as $0 based on your income, and after 20 to 25 years, any balance remaining on your debt is wiped out completely.
Although the end results are the same, there are benefits and drawbacks to both rehabilitation and consolidation. Below is a list of which program is better based on various factors.
Consolidation is permitted as a matter of right. After you must fill out a form your loans will be consolidated shortly afterward. There is no arguing or negotiating with lenders and your personal finances are irrelevant.
With rehabilitation, many lenders will argue over what your reasonable and affordable payment should be. Although such a payment can be as little as $5, many lenders will wrongfully and incorrectly tell you what payments they can or cannot accept. This means that rehabilitation often requires a greater amount of negotiation, and possible headache, when dealing with the lender.
Additionally, if you have multiple federal loans, you will have to rehabilitate each one individually. Whereas if you consolidate, and default later when you rehabilitate at that point, you will only need to rehabilitate one loan.
Consolidation can take up to 30 days to process and complete after you have submitted your application.
That might seem much faster than the nine-month rehabilitation plan. However, with rehabilitation, assuming you can agree on a reasonable and affordable payment, you enter into an agreeable payment plan immediately. The lender will be able to forward you the paperwork documenting your agreement and payment figures the very same day you agree to them. And while you are not out of default the very first day, further collection activities will stop once you have agreed to a rehabilitation.
If your wages are being garnished, you cannot consolidate. Rehabilitation is your only option. Even if you are not in garnishment, but have received notice that it is imminent, the 30 days it will take to consolidate will likely exceed the time permitted to stop the garnishment
Once you apply for and receive a consolidation, you can apply for an income-based repayment plan. If you are unemployed or have another financial hardship, your payments can be as low as $0. Another option available after the consolidation is to use a deferment or forbearance to get a temporary reprieve from making loan payments. Either way, the end result of consolidation might be significant time making no payments.
Rehabilitation will require immediate payments. Of course, depending on your finances, the rehabilitation payments may be as little as $5 a month, making the affordability of consolidation only slightly better than rehabilitation.
Successfully completing a rehabilitation program will eliminate the default from your credit report, but it won't eliminate late payment notations or other negative marks. Although the positive effect may be minimal, it still has some benefit to your credit.
With consolidation, your credit report does not change -- the default notations and other negative remain on your report.
Neither plan will save you more interest or collection fees than the other, or lower them by any appreciable amount. Both, however, will save you interest and collection fees when compared to doing absolutely nothing.