Student Loan Rehabilitation vs. Consolidation: A Complete Comparison

As of the third quarter of 2024, 4.1 million federal student loan borrowers were in default, according to the Federal Student Aid office. Defaulting on federal student loans has serious consequences, including loss of access to federal benefits and potential wage garnishment. If your loans are in default, you should try to resolve this as soon as possible.

Loan rehabilitation and consolidation are two options for getting out of default without immediately repaying your loans in full. There are some important differences between student loan rehabilitation vs. consolidation, including eligibility requirements, impact on your credit, and repayment options after the process is complete. Learn more in this guide.

What is student loan rehabilitation?

With student loan rehabilitation, you keep your current loans but take steps to get them out of default and restore them to repayment status.

You can contact your loan servicer to sign up for rehabilitation. Requirements depend on whether you have Perkins Loans or Direct or FFEL Loans.

If you have a Direct or FFEL Loan, you must:

1. Mail or fax a copy of your latest tax return or tax transcript to the Department of Education (ED): The ED uses this to calculate your new monthly payment amount. If you're married but file separately, you must also include your spouse's tax returns.
2. Enter into a written agreement with your loan servicer to make nine "voluntary, reasonable, and affordable" monthly payments: You'll receive this agreement in the mail within 10 business days of sending your income information. Reasonable and affordable payments are set by lenders and equal 10% or 15% of your discretionary income, divided by 12. Your discretionary income is the amount of your adjusted gross income that exceeds 150% of the poverty guideline for your family size and state. You must sign the agreement and return it to the ED.
3. Make nine required payments within 20 days of the due date over 10 consecutive months: If you can't afford your payment, ask your loan servicer to create an alternate payment plan to avoid losing your opportunity to rehabilitate your loans. If payments are being collected through a garnishment order or Treasury offset, these may continue until you've made at least five payments or until your loan is out of default - but they won't count toward your rehabilitation payments.

If you have a Perkins Loan, the rehabilitation process is similar, but you must make full payments within 20 days of the due date for nine consecutive months.

After you've made the nine required payments, your loan will be removed from default status. All federal borrower benefits will be restored, including access to deferment, forbearance, loan forgiveness, and income-driven repayment plan options. The record of the default is also removed from your credit history, although a history of late payments leading up to the default won't be removed.

Pros of rehabilitation

Rehabilitation has both benefits and disadvantages. Here are the biggest perks:

• You can restore access to federal borrower benefits and stop wage garnishment or Treasury offsets.
• You become eligible for federal student aid again.
• You can improve your credit by having the default record removed.

Cons of rehabilitation

These are the biggest downsides:

• Garnishment and Treasury offsets may continue as you work to rehabilitate your loans.
• It takes at least nine full months for loans to come out of default.
• You must rehabilitate each loan individually.

What is student loan consolidation?

Student loan consolidation involves applying for a Direct Consolidation Loan, which will pay off the defaulted debt. You'll eliminate your current defaulted loans and get a new loan altogether.

You can use a Direct Consolidation Loan for many purposes, not just to get out of default. Many borrowers use this loan to simplify repayment of multiple loans, even if they aren't behind on payments. However, if you're using student loan consolidation to get out of default, there are specific requirements you must meet:

• Either make three full on-time monthly payments consecutively and voluntarily on the defaulted loan(s) before you consolidate or agree that you will repay your new Direct Consolidation Loan using an income-driven repayment plan.
• If you are in default on an existing Direct Consolidation Loan (rather than on other types of student loans), then you must include at least one other eligible loan in the consolidation, as well as meet one of the two requirements above.
• You must not have a current wage garnishment order or any other court order in place for debt collection. If you have an existing court order against you, it will need to be lifted or vacated in order for you to be eligible for consolidation.

Once you've met these requirements, you can apply for a Direct Consolidation Loan online. Then, you'll need to select your repayment plan. If you didn't agree to make payments under an income-driven plan, and instead chose to make three consecutive on-time payments before consolidation, you can choose any plan you're eligible for.

Your new loan will be eligible for all federal borrower benefits, such as forbearance, deferment, and forgiveness. Unfortunately, the record of your default will not be removed from your credit history.

Pros of consolidation

There are pros and cons of consolidation to think about. Here are some of the biggest pros:

• You can get out of default much faster than you would with rehabilitation, since you don't have to make nine monthly payments.
• You can get out of default on multiple loans at once by consolidating them all, rather than having to individually rehabilitate each one.
• Direct Consolidation Loans have more repayment plan choices than other types of student loans, including plans with longer repayment timelines that result in more affordable monthly payments.

Cons of consolidation

Some of the biggest disadvantages include:

• Your default isn't removed from your credit history.
• You have to remove wage garnishment orders before you can move forward.
• You won't get to keep your existing loans or loan servicer.

Current student loan refinance rates

Comparing loan rehabilitation and consolidation

If you've defaulted on your student loans, it's important to compare both rehabilitation vs. consolidation carefully to decide which is the right one for you. Both allow you to restore access to federal benefits, but there are a few big differences between the two, including speed, eligibility rules, and impact on your credit report.

“Loan rehabilitation helps borrowers remove the default status after a series of on-time payments, thus restoring their credit,” explains Chad D. Cummings, certified public accountant and attorney at The Law Office of Chad D. Cummings.

Since rehabilitation removes the record of the default from your credit history and consolidation doesn't, rehabilitation is the better choice if your primary concern is cleaning up your credit.

If your goal is to get out of default as soon as possible, then consolidation is best. You can consolidate defaulted loans right away as long as you don't have a wage garnishment order and are willing to select an income-driven repayment plan. With rehabilitation, you'll need nine months of payments to come out of default, so the process is slower.

You can also consolidate loans multiple times, while rehabilitation is a one-time deal. And, if you have multiple loans in default, consolidation can make it much easier to address them all at once since you can consolidate multiple debts together.

Ultimately, the best option depends on your specific goals. “Consolidation is ideal for simplicity, while rehabilitation is essential for credit repair,” says Cummings.

When to choose loan rehabilitation

Rehabilitation is the right choice for many borrowers in default since, unlike consolidation, restoring defaulted loans to repayment status is the sole purpose of this program.

“Student loan rehabilitation should be considered when you have already defaulted on your loans,” says Jason Fannon, certified financial planner and senior partner at Cornerstone Financial Services. “This process allows you to negotiate a payment agreement and return the loans to 'current.' The purpose of bringing your loan back to repayment status is to eliminate a negative credit rating and to prevent any potential wage garnishment,” explains Fannon.

Having the default removed from your credit history is a huge benefit, as a good credit record impacts every aspect of your financial life. As long as you are confident you can make nine months of payments and you don't need to group multiple loans into one big loan, you should consider pursuing this option.

When to choose consolidation

Consolidation does not provide the same benefits to your credit as rehabilitation, but it can still be the right choice under certain circumstances.

“Student loan consolidation should be considered when you want to streamline or simplify the payment process,” says Fannon.

If you have multiple defaulted loans, you can apply for one Direct Consolidation Loan for all of them. Even if you don't have multiple defaulted loans, it can still be convenient to combine the debt you do have and make a single monthly payment instead of many.

Consolidation can also be a great choice if you don't qualify for rehabilitation because you already rehabilitated your loans once. And if you need to get out of default right away and can't wait, consolidation is probably your best bet.

“You should be able to complete consolidation within six to eight weeks,” explains Domenick D'Andrea, accredited investment fiduciary and co-founder of DanDarah Wealth Management. “This will help you start on the path to fixing your credit quicker than rehabilitation.”

While you would need to choose an income-driven plan if you didn't make three on-time payments before consolidating, income-driven plans are often the best choice anyway.

Ultimately, both rehabilitation and consolidation are better options than staying in default. The key is to carefully consider both choices to decide which is best for you.