Kathy Kristof

A recent study of student loan holders showed that roughly 40 percent of them fall behind on payments or end up in default.

The effect of delinquency on a student loan is bad, but default is tragic, experts say.

"It seriously impacts the student's credit rating, causes them to pay increased fees on the loan and can make it impossible for them to go back to school," said Gary Brahm, chancellor of Brandman University in Irvine, Calif. "These become really tragic individual stories."

The stories are possibly more tragic because repayment woes are relatively easy to avoid in today's student loan marketplace, where options have been expanded to give borrowers more flexibility. Some experts believe that students would never fall into default if they understood the process and knew about the options.

Here's a lesson in how the loans work, post graduation.

Borrowers are given six months' grace on student loans after graduation. During that period, no payments need to be made, but notices will come from lenders to spell out the total amount due and give a date for the first payment. If borrowers don't request otherwise, monthly payments will be based on the standard repayment formula, which will have the debt repaid within 10 years.

If a borrower does nothing, the first monthly payment will be expected in the seventh month after graduation. If that payment is not made, the loan becomes delinquent.

But it's usually not until a payment is 60 days late that bad things start to happen. That's when lenders typically report a late payment to the three major credit bureaus, which will notate the delinquency on a credit report.

That could be bad for a person's financial future. Delinquencies can reduce a credit score, which is used by lenders when considering all kinds of loans. In addition, many insurance companies use credit scores to help determine rates. Some employers even check the credit reports of job candidates.

Every month a student loan is unpaid, the credit score can be further dinged. After nine months of delinquency the loan goes into default, and then the consequences get really ugly.

A loan in default is transferred to a guarantor -- an agency or person who has guaranteed the student loan, usually for a fee. The guarantor will usually contact the borrower and ask if there are extenuating circumstances that led to the default. Was the loan balance improperly calculated or did the lender fail to communicate what the borrower owed?

If not -- or if the borrower doesn't respond at all -- the loan could be accelerated. That means that the full amount, including principal and interest, will be due and payable within 120 days.

If the loan is not repaid in full during that time, the lender has the right to assess a collection fee amounting to 18 percent of the total (which includes all the interest charges that have accrued while the loan was delinquent).

"It's an enormous increase in the amount you owe," said Kim Carter, manager of repayment assistance at American Student Assistance in Boston, Mass.

In addition, the lender has the right to seize both a portion of the borrower's wages and any tax refund that might be due. The default could cost thousands of dollars and ruin the borrower's credit for years.

But there's almost no reason for a graduate to be forced into default, said Maria Wasserman, managing director of operations at All Student Loan, which offers consolidated loan packages and other services.

Student loan payments can usually be deferred when borrowers are unemployed or underemployed for up to two years. If the borrower goes back to school, payments can be postponed almost indefinitely.

If the borrower runs out of deferment options, he or she can ask for forbearance, Wasserman said, which will also delay payments. Lenders are not required to approve forbearances, but many will if they determine the borrower has no means to afford payments at that point.

If the forbearance is denied, a borrower's best option may be to sign up for the federal government's income-based repayment plan. It calculates monthly payments as a percentage of a borrower's discretionary income.

The most important thing, Carter said, is to get educated about student loan payments during the six-month grace period. That can help you avoid costly mistakes later.

"You have a lot of options," Wasserman said. "Waiting to find out what they are until after you go into delinquency or default is too late."

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