I used to have 2 student loans in default so I have a lot of experience with this. First off, here's some information from the federal student loan servicing website (www.dl.ed.gov):
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Rehabilitation or Consolidation?
There are many benefits to rehabilitating a defaulted loan before consolidation. If you consolidate a defaulted loan without rehabilitating it, your credit record continues to show a default status on the loan. This is true even after the consolidation loan pays off the defaulted loan in full.
* Consolidating a defaulted loan will result in your credit report bearing the notation that the loan was in default but then "paid in full." This notation will remain on your credit report for up to seven years. While a "paid in full" notation is preferable to an unpaid default, there is still the possibility that lenders will deny you future credit, such as mortgages, auto loans, or credit cards because of this notation.
However, if you rehabilitate a defaulted loan before consolidating it, the loan holder will update your credit record to no longer reflect the default status of the rehabilitated loan(s).
* Rehabilitating a defaulted Direct Loan or FFEL loan requires that you make at least nine (9) full payments of an agreed amount within twenty (20) days of their monthly due date over a ten (10) month period to the U.S. Department of Education (Department). Rehabilitating a defaulted Perkins loan requires twelve (12) on-time monthly payments of an agreed amount to the Department. Contact your loan holder to obtain additional rehabilitation terms and conditions for your loan type.
Keep in mind that if you default on your loan, you are liable for any collection costs incurred to collect the loan. If you pay off the defaulted loan by taking out a Consolidation Loan, the amount you borrow must be enough to pay off your defaulted loan, including principal, interest, and collection costs. This means that the amount of the new loan may need to be up to 18.5% larger than the principal and interest outstanding on your defaulted loan.
Both rehabilitation and consolidation will reinstate eligibility for additional Federal student aid under Title IV of the Higher Education Act (Pell Grants, FFEL and Direct Loans, etc.).
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In a nutshell, it's probably better to go through the long rehabilitation program rather then paying it in full...just to get the negative items removed.
About 3 years ago, I started the rehabilitation process. After making 12 consecutive monthly payments, I received a couple letters stating that my loan would be taken out of default on my credit reports. However, what happened to me was that one account in "good standing" popped up on my CR's and the 2 defaulted ones stayed on. When I contacted them about it, they said that they reported them as not being in default status and there was nothing they could do about it. They advised me to dispute them with the CRA's and I did. Approx 30 days later, they were removed. All in all, it took me about 14 months to get them removed but it was worth getting rid of the negative items.
Message Edited by danx on 06-02-2007 10:22 AM