Can You Settle Student Loan Debt for Less Than You Owe?

student loan debt settlement

It’s safe to say that none of the 3.3 million Americans with defaulted student debt ever hoped to wind up in such a precarious situation when they originally borrowed their loans.

The very real threat of debt collectors knocking at your door, wage garnishment, offset taxes — or worse, legal action — are consequences that can pose major personal and financial damage if you’ve let your loans go unpaid.

We often hear about credit card debt settlement, but can you successfully negotiate and get your student loan balance settled before the problem gets to that point?

In a word, yes. Student loan debt settlement is possible and borrowers can arrange to pay less than what they originally owed. But it does come with some considerations, and there are alternatives to think about if you find yourself in default.

Can you settle student loan debt?

If you’re current on your loans, or — as we’ll talk about below — you have enough cash reserve to pay down your debt, you aren’t eligible for settlement. It is only available if you’re in default on your student loans.

In general, the time to pursue debt settlement is after you’ve gone into default (and the collections process has begun), but before any legal moves have been made.

A loan settlement isn’t the same thing as loan forgiveness or discharge, where your loan balance is canceled under special circumstances. It’s not a refinance or amended payment plan, either.

With a settlement, your lender is essentially striking a deal to “settle” for a lower amount than what you borrowed if it means resolving your debt without the need for collections, court judgments, or other actions.

With a federal student loan settlement, borrowers have one of three standard payment options through private collections agencies, via the US Department of Education:

  • You can pay all your current principal balance, plus accrued, unpaid interest, with any future collection surcharges and fees waived;
  • Pay the total principal with half of your interest balance (the other 50 percent is forgiven);
  • Pay 90 percent of the total principal and balance owed (10 percent discounted).

If you’re in default, any one of these three settlement alternatives may seem like a godsend. But there’s a catch. The government will expect you to pay your student loan debt settlement in one lump sum, usually 90 days from the settlement agreement date, so you’ll need to be prepared to muster up the cash for it.

Even with collection fees waived (settlement option one) or a percentage of your principal/interest deducted (options two and three), that’s still a lot of money to pay at once. You may also owe taxes on any unpaid interest forgiven as part of a debt settlement.

There are instances when the Department of Ed may allow you to pay your settlement balance in monthly installments (just like you would with regular monthly loan repayments), but they’ll need to be paid within one fiscal year, according to FinAid.org.

Where you might generate that kind of cash for a big settlement payment is up to your own circumstances, so examine your situation carefully if you’ve arrived at a settlement agreement with your lender.

Just as with negotiating interest rates, private student loans can also be settled. Unlike federal loans, APRs can vary from lender to lender, so the terms, conditions, and amounts you may be able to negotiate could differ from those through the US government.

When you can’t settle student loan debt

In some cases, student loan debt can’t be settled. If any of the following apply to you, you could be ineligible.

1. You’ve deliberately defaulted on your loans just to settle.

Also called “strategic default,” this is a form of fraud that can land you in bigger trouble. By holding off on your payments, it sends the message to your lender that you’re forcing them to settle.

If you hold off making your payments and become delinquent with the intent to go into default on purpose, you’ll lose the choice to settle and you’ll still owe your entire balance — plus, interest continues to accrue.

2. A court judgment has already been issued against you.

Once lawsuits have been filed, judgments have been made, and you’ve been ordered to pay your lender what you owe, it’s too late in the game to request debt settlement.

3. You’ve come into a disproportionately large sum of money.

According to financial aid expert Mark Kantrowitz, lenders won’t typically approve a settlement if you have enough cash to make your loan payments or pay your debt balance in full.

If, for example, you received an inheritance, won the lottery, or were granted a big raise at work, it’ll be harder to prove the financial hardship necessary to seek out a debt settlement to begin with.

How to settle student loan debt

A collection agency, whether through the US government or private lender, won’t usually settle a defaulted student loan debt if it’s less than the amount that the lender is likely to receive over the life of the original loan — so negotiation is essential during settlement talks.

Do you go it alone or hire a student loan attorney? A lawyer can help you navigate the often confusing landscape of negotiations. The fees and rates they charge may still be worth the cost if they can get you a good settlement, and could be a welcome alternative to learning how to settle student loan debt yourself.

If you decide on the DIY route, experts strongly discourage against guilt-tripping your lender into settling or complaining about your debt. It’s also not advisable to mention extra assets that a lender could try to garnish in collections, or to take the first offer that comes along.

When a settlement is reached, always make sure to get it in writing. It’s recommended to have an attorney review the contract to ensure it’s legally binding.

This will also guarantee that your lender fulfills their end of the settlement, too, which should include a final statement indicating that you’ve paid off your debt in full. Ensure that your agreement includes all of the debts you’re intending to settle and that none (federal or private) are omitted.

Impacts, consequences, and alternatives to student loan debt settlement

A student loan debt settlement can have a negative impact on your credit report and FICO score, since it indicates that you’ve gone into both delinquency and default on a loan. However, a settlement is the lesser of two evils and doesn’t affect your credit score as badly as a collection or judgment might.

In this case, it’s perfectly acceptable to request that your lender reports the settlement as a paid-in-full account instead of a settled debt, or to remove the default label from your credit report. With no more delinquency or default status on file, your credit score may actually see improvement.

Ultimately, before developing a pattern of consistent delinquencies that could lead to default, communicate with your lender(s) first about your options. See if you’re eligible for amended payment plans, refinancing, deferment, or forbearance on your student loans. Look into income-based repayment plans, which calculate the monthly amount you owe on your student loans based on your current take-home pay.

In addition to building a budget and paying down your student loan balance on time, make sure you’re aware of how much you owe, how many loans you have, the total balances for each, and what your terms and interest rates are.

Checking the National Student Loan Data System as well as consulting your credit report are two essential resources to avoid falling behind on your loans, ensuring that default and student loan debt settlement never enter the picture.

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