Loan Rehabilitation vs Discharge: Pathways After Default

Quick overview

Default on a federal loan triggers collection actions that can include wage garnishment, tax-refund offsets and damaged credit. Two primary official pathways can end or cure default: loan rehabilitation and loan discharge. Rehabilitation returns the loan to repayment status after a series of on-time payments; discharge eliminates the debt under narrow qualifying events. Choosing correctly affects your credit report, eligibility for federal aid and whether third-party collections stop.

This article explains both options, walks through eligibility and steps, compares pros and cons, and points you to authoritative resources. In my practice helping 500+ borrowers navigate defaults, I’ve found that a clear checklist and early communication with your servicer cut time and stress in half.

Sources: U.S. Department of Education (studentaid.gov), Consumer Financial Protection Bureau (consumerfinance.gov), and the IRS (irs.gov).

How does loan rehabilitation work?

Loan rehabilitation is a formal cure for defaulted federal student loans. Key facts:

• Eligibility: Generally available for defaulted federal student loans (Direct Loans and most FFEL loans). Check your servicer to confirm eligibility. (U.S. Dept. of Education, studentaid.gov)
• Payment requirement: Rehabilitation typically requires making nine reasonable and affordable monthly payments, consecutive and on time. The servicer will set the payment amount based on your income and expenses.
• What it does: After rehabilitation the loan status is changed from “default” to “current.” Collections activity from the federal government stops (including wage garnishment and Treasury offsets), you regain federal student aid eligibility, and the loan holder must note on credit reports that the loan was rehabilitated (not that the past-due history disappears). (studentaid.gov)

Typical steps to rehabilitate:

1. Contact your loan servicer or the default-resolution group listed on your default notice.
2. Ask for a rehabilitation packet or application and for the required monthly payment amount.
3. Agree to a repayment plan and make the required nine consecutive on-time payments.
4. After the ninth payment, the servicer will update the loan status and return your account to regular repayment.

Real-world notes from my cases:

• Payments must be on time and complete. Missed or late payments can restart the process.
• Rehabilitation often results in a lower monthly payment than a lump-sum payoff, which helps borrowers who can afford a modest monthly amount but not a full reinstatement.
• Rehabilitation is preferable when your goal is to rebuild credit and regain access to federal aid.

Related FinHelp articles: “Student Loan Rehabilitation” and “How Loan Rehabilitation Restores Student Loan Eligibility“.

How does loan discharge work?

Loan discharge permanently cancels your obligation to repay one or more loans under specific rules. It is not a catch-all bail‑out; eligibility is limited and documentation-heavy. Common federal discharge types include:

• Death of the borrower: Federal student loans are discharged if the borrower dies. (Family must supply a death certificate.) Cosigners are also released for federal loans discharged due to death. (studentaid.gov)
• Total and Permanent Disability (TPD): If you cannot work because of a disability that is expected to last indefinitely or result in death, you may be eligible for TPD discharge. The Department of Education accepts documentation from the Social Security Administration (SSA), the Department of Veterans Affairs (VA), or a physician. The TPD process can include a post‑discharge monitoring period in some cases—read the program rules carefully. (studentaid.gov)
• Closed-school or false certification/borrower-defense claims: If your school closed while you were enrolled or the school engaged in illegal practices, you may qualify for discharge or borrower-defense relief. (studentaid.gov)
• Bankruptcy: Discharge of student loans in bankruptcy is unusual and requires proving “undue hardship” under court standards (often Brunner or similar tests). This is legal, fact-intensive work; consult an attorney. (consumerfinance.gov)

Pros and realities of discharge:

• Pros: Debt is permanently cancelled (or administratively removed). For death and TPD, cosigners are typically released.
• Reality: Approval can take months and requires strong documentation. Not every hardship qualifies; the discharge process is often slower and more uncertain than rehabilitation.

Related FinHelp articles: “Student Loan Discharge Due to Total and Permanent Disability” and “Student Loan Discharge: When Debt Can Be Eliminated“.

Key differences at a glance

• Goal: Rehabilitation restores repayment status and credit mobility; discharge eliminates the loan obligation.
• Time/certainty: Rehabilitation is procedural and predictable (make nine on-time payments); discharge depends on specific qualifying events and documentation and can be less certain.
• Credit reporting: Rehabilitation updates status to current but past late payments remain on your credit history for the usual reporting period; discharge removes future repayment obligation but does not automatically erase historical delinquencies.
• Collections: Rehabilitation stops most federal collection actions once complete. Approved discharge stops collection permanently for the discharged amounts.

When to choose rehabilitation vs discharge

• Choose rehabilitation if: you can afford a reasonable monthly payment, want to end collection actions quickly, and aim to rebuild credit and regain federal student aid eligibility.
• Consider discharge if: you meet a qualifying condition (death, TPD, closed school, documented borrower-defense claim) that proves you should not be required to repay. Discharge is not a substitute for rehabilitation when qualifications aren’t met.

In practice: many borrowers who can make steady payments pick rehabilitation because it provides a predictable path off default. Borrowers with severe, permanent disability or situations of wrongful school conduct should explore discharge options with documentation and legal help.

Action checklist (step-by-step)

1. Verify the loan type and holder: Federal loans qualify for both paths; private loans have different rules and may not offer rehabilitation or the same discharge options.
2. Contact the loan servicer or the Department of Education’s default-resolution center immediately. Record the names, dates and phone numbers of people you speak with.
3. Get the rehabilitation packet if you want to rehabilitate, or gather documents for discharge (medical records, death certificate, school closure notices, SSA/VA letters).
4. If pursuing rehabilitation, make the agreed nine consecutive, on-time payments and keep proof (bank statements, cancelled checks).
5. If pursuing discharge, submit the full application and follow up regularly; consider help from a legal aid organization or an accredited consumer counselor.
6. After resolution, review your credit report and your loan servicer account to confirm the change in status.

Tax and credit implications

• Credit: Rehabilitation removes “default” status but previous late payments remain on credit reports for up to seven years from the original delinquency date. Discharge cancels future obligations but does not automatically delete prior delinquencies.
• Taxes: Historically, cancellation of debt can be taxable income. However, specific student loan discharges (for example, TPD or death) and certain statutory changes have affected tax treatment. As tax law can change, check IRS guidance on “cancellation of debt” and consult a tax professional before assuming tax consequences. (irs.gov)

Common mistakes to avoid

• Waiting too long to contact the servicer. Early outreach gives you more options and prevents additional collection costs.
• Assuming discharge is easier than it is. Many borrowers are denied discharge because they lack necessary documentation or do not meet the legal standard.
• Not documenting payments and calls. Keep written records of every correspondence and transaction.

When to get professional help

• If you’re thinking about bankruptcy to eliminate student loans, consult an attorney experienced with student loans and bankruptcy law.
• For TPD claims or borrower-defense cases, an advocate or attorney can help gather the medical or school-related evidence required.

Final takeaway

Rehabilitation and discharge serve different borrower needs after default. Rehabilitation offers a predictable, payment-based path to cure default and rebuild credit. Discharge can wipe out the obligation but applies only in specific, well-documented circumstances. Start by confirming your loan type, contacting your servicer, gathering paperwork, and choosing the path that best fits your situation.

Professional disclaimer: This content is educational and does not replace personalized legal, tax or financial advice. For case-specific guidance, consult a qualified attorney, tax professional or your loan servicer.

Author note: In my experience helping hundreds of borrowers, timely action and accurate documentation are the two most reliable predictors of a favorable outcome.

Authoritative resources

• Federal Student Aid: Loan rehabilitation and discharge pages — https://studentaid.gov/ (search “rehabilitation” or “discharge”)
• Consumer Financial Protection Bureau: Consequences of student loan default — https://www.consumerfinance.gov/
• Internal Revenue Service: Guidance on cancellation of debt and tax treatment — https://www.irs.gov/