How to Win at Debt Settlement Negotiations

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With more than 1 in 10 student loans either delinquent or in default, many borrowers are looking for a way to settle their financial dilemmas. Negotiating student loan debt is a strategy that some use to lower their outstanding balance so they can more easily pay it off.

But student loan debt settlement is really for extreme cases, and it comes with some drawbacks. Here are some things you need to know before you start debt settlement negotiations, as well as some other possibilities if it isn’t right for you.

When is negotiating student loan debt an option?
How to get a student loan settlement
Repercussions of student debt settlement negotiations
Alternatives to student loan debt settlement
FAQs: Negotiating student loan debt

When is negotiating student loan debt an option?

Your ability to negotiate your student loan debt will depend largely on whether your loans are federal or private. One thing that both have in common is that the loan must be in default, said Joshua Cohen, attorney and founder of thestudentloanlawyer.com, “No one can settle on a working loan.”

Still, with more than 5 million borrowers estimated to be in default with their student loans as of the end of 2018, such negotiations aren’t that uncommon. Here’s when they’re an option:

Federal

  • The loan is in default. Before you can even start to negotiate on a federal student loan, Cohen said your loan needs to be in default, usually meaning it’s at least 270 days (about nine months) past due.
  • You have a lump sum to make the settled payment. According to Cohen, when you negotiate a federal student loan debt, you must pay the negotiated amount as a lump sum within 90 days.

Private

  • The loan is in private student loan default. Like federal loans, private loans must usually be in default to negotiate. But according to Cohen, private loans are often placed in default after they’re only 90 to 180 days past due.
  • The loan has been charged off and is in collections. Once a loan is far enough past due, the debt is charged off and sent to a collection agency. As Cohen said: “Private loans are much like credit cards. You still have to default, and after four to six months you are charged off, meaning deemed uncollectable. [Lenders] can still come after you though.”
  • You have a lump sum to pay for it. As with federal loans, you’ll generally want to be ready to pay a negotiated private loan debt with a lump sum payment. You may be presented with the option of a payment plan, but Cohen advises people to think twice before accepting these: “With private loans, many debt collectors will offer a payment plan, but that’s a trap.” This is because the collection agency might transfer the loan to a different collector before the plan is done, and you could have to negotiate a new deal from scratch, he said.
  • Waiting out the statute of limitations isn’t viable. Many U.S. states have a statute of limitations for debt, after which the debt becomes unenforceable. Sometimes, though, this would involve dodging collectors for years and isn’t practical. Also note some actions can “reset the clock” on the statute of limitations date — “In the most consumer-friendly states, you have to actually make a payment to reset the statute. But in some states, just acknowledging the debt resets it,” Cohen said. You can find out more here.

How to get a student loan settlement

Here’s a step-by-step walkthrough of how (ideally) a student loan settlement would happen:

1. Approach the lender about settling student loan debt
2. Negotiate the debt settlement
3. Get the agreement in writing
4. Pay the agreed-upon amount

1. Approach the lender about settling student loan debt

You’ll want to open negotiations with your creditor with a polite tone. If the loans are federal, you probably won’t need a student loan attorney, since the government will likely offer you the same options regardless.

But Cohen said it may be worthwhile to get legal counsel if you’re trying to settle a private student loan. “Since you are dealing with a debt collector, you are protected by the Fair Debt Collection Practices Act, so [collectors] can only bother the lawyer not the borrower,” he said.

2. Negotiate the debt settlement

There are some significant differences between types of settlement for federal loans versus private loans. Additional differences come into play when negotiating with debt collectors.

Federal

Federal loans and those held by the Department of Education have three options used in almost all cases for settlement offers:

  • Waiver of fees with payment of 100% principal and interest
  • 90% principal and interest
  • 100% principal and 50% interest and fees

Private

According to Cohen, private loan settlement offers will depend on the lender, but they often follow these guidelines:

  • For a defaulted loan that hasn’t been charged off or sent to a debt collector: 70% to 80% of the balance
  • For a loan roughly six months in default that has been charged off and is with a debt collector: 60% to 80% of the balance
  • After two years with no payment: 20% off the balance

Debt collectors may offer an even lower settlement after the statute of limitations runs out.

3. Get the agreement in writing

A verbal agreement isn’t what you’re looking for when you attempt to settle student loan debt. Instead, you want the terms fully spelled out in writing through a debt settlement letter.

“Don’t pay until you get a written offer. If they say they won’t give you one, hang up and call back and get a different person,” Cohen said.

4. Pay the agreed-upon amount

Negotiated federal loans need to be paid in full within 90 days of receiving the written agreement. In most cases, unless you can negotiate a very short timeline for private loan repayment, these should also be paid in a lump sum after receiving the written offer.

Save your final statement once the lender sends it out. If they don’t send a final statement, request a letter that shows the account was settled in full. Then, monitor your credit report to ensure that the loan appears as settled and paid.

Repercussions of student debt settlement negotiations

Student loan debt negotiation may free you from some of your debt, but it comes at a price. Let’s look at some of the repercussions you may face upon settling:

  • It can impact your credit score. Despite settling a student loan, your credit history and score will still reflect the delinquency and default for seven years.
  • You’ll likely owe taxes on the written-off student loan debt. Canceled debt is generally taxable by the IRS, so you will probably receive a 1099-C for the amount written off, and you’ll need to report it when you file taxes for the year.
  • Settlement might wipe out your savings. Federal loan settlements must be paid at once, and it’s a good idea to do the same with private loans. This isn’t easy for many borrowers and could wipe out your savings. And as Cohen advised: “If [making the payment means you] don’t have enough money for groceries, then you really shouldn’t have paid the lump sum.”

Alternatives to student loan debt settlement

Student loan debt settlement, especially when it requires a large lump-sum payment, isn’t an option for everyone. Some alternatives include:

1. Negotiating a repayment plan
2. Income-driven repayment plans
3. Student loan forgiveness programs
4. Refinancing
5. Bankruptcy or discharge

1. Negotiating a repayment plan

Private student loan lenders who don’t want your loan to go into arrears or be charged off may agree to a new plan that lowers your monthly payments. Contact your lender directly to find out what they can do. Still, some may be unwilling to negotiate a new repayment plan unless your loan is in default.

2. Income-driven repayment plans

When your income isn’t enough to service your federal student loan debt, you may qualify for an income-driven repayment plan, or IDR. These plans can cut your monthly payments to an affordable percentage of your disposable income, and after a given period of time (usually 20 or 25 years), any remaining debt balance is forgiven.

There are currently four options for income-driven repayment:

3. Student loan forgiveness programs

There are several federal student loan forgiveness programs that may wipe out a portion of your remaining student loan debt if you qualify. Cohen reminds borrowers that applying for forgiveness requires that they continually check qualifications. Some programs — such as Public Service Loan Forgiveness (PSLF) — are notoriously hard to qualify for.

Also note that there are programs to pay back a portion of your loan, even if you don’t get full forgiveness. These are called loan repayment assistance programs (LRAPs), and they vary by location, profession and other factors. You can check out our database of these options for more information.

4. Refinancing

Refinancing a student loan swaps your current debt for a new (private) loan. This offers the chance to snag a lower interest rate, as well as to change the term (time length) of the loan. By refinancing, you could save a lot of money, but you’ll need either a strong credit history or a creditworthy cosigner.

But Cohen noted that with federal loans, refinancing can sometimes be a mistake, since you’ll lose your federal loan benefits like IDR plans and forgiveness options. There may be a point to refinancing federal student loans if you have the money to pay the loan off quickly, but Cohen advises thinking it through before rushing into things.

5. Bankruptcy or discharge

If you were defrauded by a for-profit school or if it closed right after you graduated, you could be eligible to get your debts discharged (wiped away) through the borrower defense to repayment rule. That said, the government has recently made changes to this rule, so be sure to check on the latest requirement and act quickly.

Unfortunately, student loan debt is usually not dischargeable under Chapter 7 or Chapter 13 bankruptcy, at least under current regulations, but Cohen said that there are times when it can be done.

“Bankruptcy can help even if it doesn’t offer a full discharge, because you can argue undue hardship.” To prove hardship, a borrower needs to show the bankruptcy court that they have an ongoing financial situation that prevents them from maintaining a minimal standard of living if they continue paying the loan, and that despite this they’ve made a good faith effort to pay.

FAQs: Negotiating student loan debt

  • What’s the statute of limitations on student loans? The statute of limitations varies by state. Once a statute has run out, a lender can no longer sue a borrower, but it might be worth negotiating a settlement and paying the loan off just to start repairing your credit.
  • Do you need a lawyer when negotiating student loan debt? No, although if it’s a private loan then having a lawyer can mean avoiding contact with debt collectors. In addition, having a lawyer means being able to review alternatives, including bankruptcy.
  • What gives a borrower the most leverage when negotiating? According to Cohen, the answer is time. “Time allows [a borrower] to build up savings, and the debt collector to reduce what they’re looking for,” he said.
  • What if a student loan has a cosigner? Cohen said that the settlement will generally include the cosigner, and that often it might be possible to release the cosigner.

This blog does not provide legal advice. If you need legal advice, please contact an attorney directly. Individual results may vary.

Shannon Insler contributed to this report.